Economic Incentive Program Rules; Final Rule ENVIRONMENTAL PROTECTION AGENCY

SUMMARY: This action promulgates rules for economic incentive programs

(EIP's) which either may or must be adopted by States for certain ozone

(O3) and carbon monoxide (CO) nonattainment areas upon the failure

of a State to submit an adequate showing that an applicable reasonable

further progress (RFP) or a specific emissions reductions milestone has

been met (in serious, severe, and extreme O3 and serious CO

nonattainment areas) or upon the failure of a serious CO nonattainment

area to attain the national ambient air quality standards (NAAQS) for

CO. Under the Clean Air Act as amended in 1990 (Act), the EPA was

required to promulgate final EIP rules for stationary, area, and mobile

sources by November 15, 1992; this action is that rulemaking.

The provisions of today's rules are also guidance for discretionary

EIP's that any State may choose to adopt for any criteria pollutant, as

explicitly allowed for in the Act. The Agency views this action as an

opportunity to encourage the development and early implementation of

appropriate EIP's. In so doing, the Agency hopes these rules and

guidance will stimulate the adoption of incentive-based, innovative

programs, where appropriate, that will assist States in meeting air

quality management goals through flexible approaches which benefit both

the environment and the regulated entities, allow for less costly

control strategies, and provide stronger incentives for the development

and implementation of pollution prevention measures and innovative

emissions reductions technology.

The EPA intends that the portion of the preamble and rules

published today that concern discretionary EIP's constitute guidance,

not final action. Final action with respect to discretionary EIP's will

occur when the EPA approves or disapproves State implementation plan

(SIP) revisions containing discretionary EIP's.

EFFECTIVE DATE: The regulations in this rulemaking go into effect on

April 7, 1994.

ADDRESSES: The public docket for this action, A-91-56, including copies

of the public comments on the EPA's February 23, 1993 proposed

rulemaking, is available for public inspection and copying between 8

a.m. and 4 p.m., Monday through Friday, at the address listed below. A

reasonable fee for copying may be charged. The address of the EPA Air

Docket is EPA Central Docket Section, South Conference Center, room 4,

401 M Street, SW, Washington, DC 20460.

FOR FURTHER INFORMATION CONTACT:

Mr. Willis P. Beal, U.S. EPA, MD-12, Research Triangle Park, North

Carolina 27711, telephone (919) 541-5667.

SUPPLEMENTARY INFORMATION: The contents of today's preamble are listed

in the following outline:

I. Background and Purpose

A. Introduction

B. Overview

C. Principles and Regulatory Elements

II. Summary of Rules and Guidance

A. Applicability

B. Definitions

C. State Program Election and Submittal

D. State Program Requirements

E. Use of Program Revenues

III. Discussion of Rules and Guidance

A. Applicability

B. Definitions

C. State Program Election and Submittal

D. State Program Requirements

E. Use of Program Revenues

IV. Discussion of Comments and Regulatory Changes

A. Program Goals

B. Interface With Reasonably Available Control Technology (RACT)

and Other Statutory Requirements

C. Program Baseline

D. Emission Quantification

E. Monitoring, Recordkeeping, Reporting (MRR)

F. State Implementation Plan (SIP) Creditability

G. Audit/Reconciliation Procedures

H. Penalties for Noncompliance

I. Interface With Existing Emission Trading Policies

J. General Issues

V. Administrative Requirements

A. Executive Order 12866

B. Paperwork Reduction Act

C. Regulatory Flexibility Act

I. Background and Purpose

A. Introduction

The Act, as amended in 1990, broadly encourages the use of

incentive-based approaches to control air pollution. This encouragement

is reflected not only in the title IV acid rain program, but also in

the title I general provisions for State and Federal implementation

plans for achieving the NAAQS for criteria pollutants, as well as in

the provisions for certain Federal O3 measures. In title I,

incentive-based approaches are encouraged, and, in certain cases,

mandated, through the use of what has been termed an ``economic

incentive program.'' Today's notice promulgates rules and guidance for

EIP's adopted by the States pursuant to title I of the Act.

The Agency views this action as an opportunity to encourage and

provide guidance on the early implementation of appropriate

discretionary EIP's, as well as to provide mandated rules for use by

States after certain specific failures occur. The Agency hopes that

this guidance will stimulate the early adoption of innovative,

incentive-based approaches, where appropriate, that will assist the

States in avoiding such failures, reaching attainment of the NAAQS

faster than might otherwise occur solely through the use of traditional

regulatory strategies, and lowering the cost of attaining and

maintaining the NAAQS. Through this action, the Agency intends to

encourage the development of EIP's which benefit both the environment

and the regulated entities by increasing flexibility and stimulating

the use of less costly strategies, as well as by providing stronger

incentives for development and implementation of pollution prevention

measures, innovative emissions reductions technology, and strategies

beyond those specifically mandated through State and Federal standards

and regulations. The Agency believes that these goals can be met by

EIP's that also meet the standards of accountability and enforceability

currently found in traditional regulatory programs.

B. Overview

Today's notice promulgates rules for EIP's which may be adopted by

an authorized governing body, including States, local governments, and

Indian governing bodies (henceforth State), for certain O3 and CO

nonattainment areas pursuant to sections 182(g)(3), 182(g)(5),

187(d)(3), and 187(g) of the Act. These sections mandate for certain

areas, and identify as one of three options for certain other areas,

the use of EIP's in certain cases. An EIP is mandated upon the failure

of a State to submit an adequate demonstration showing that the area

has met applicable milestones for RFP in extreme O3 nonattainment

areas (section 182(g)(5)). An EIP is identified as one of three options

upon such failure in serious and severe O3 nonattainment areas

(section 182(g)(3)).1 Further, an EIP is also mandated upon the

failure of a State to submit a milestone demonstration showing

adequately that the area has met a required specific emissions

reductions milestone or to attain the CO NAAQS in serious CO

nonattainment areas (section 187(d)(3), 187(g)).

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\1\The other two options are to have the area reclassified to

the next higher classification and to implement specific additional

measures adequate to meet the next milestone as provided in the

applicable contingency plan.

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Section 182(g)(4)(A) of the Act requires that EIP's adopted by

States pursuant to the sections of the Act cited above, characterized

in today's notice as statutory EIP's, be consistent with the Agency's

final rules for EIP's. This section also requires that such EIP's be

nondiscriminatory with regard to applicable laws regarding interstate

commerce. In addition, section 182(g)(4)(B) imposes constraints on how

any revenues generated by such programs shall be used. The scope of the

EIP rules includes programs which may be adopted for ``reducing

emissions from permitted stationary sources, area sources, and mobile

sources.''

Other sections of title I also explicitly allow for EIP's to be

included as provisions in SIP's in general (section 110(a)(2)(A)), as

well as specifically in nonattainment area SIP's (section 172(c)(6)).

Economic incentives are allowable in Federal implementation plans

(FIP's) by definition (section 302(y)), and in Federal O3 measures

through the system of regulations for control of emissions from

consumer or commercial products (section 183(e)(4)). Today's notice

serves as the Agency's final guidance for EIP's adopted by States

pursuant to the sections of the Act relating to general SIP provisions,

characterized in today's notice as discretionary EIP's. Discretionary

EIP's may be adopted for any criteria pollutant in both nonattainment

and attainment areas.

C. Principles and Regulatory Elements

The rules and guidance in today's notice are broadly applicable to

any type of statutory or discretionary EIP, respectively. This notice

requires that EIP's submitted for approval to the EPA as part of a SIP

for a nonattainment area contain design features that will ensure that

the program will not interfere with other requirements of the Act and

that emissions reductions credited to the program will be quantifiable;

consistent with SIP attainment and RFP demonstrations; surplus to

reductions required by, and credited to, other implementation plan

provisions to avoid double counting of reductions; enforceable at both

the State and Federal levels; and permanent over the entire duration of

the program.2 The Agency does not intend to limit flexibility and

innovation beyond those constraints that are necessary to meet these

requirements.

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\2\The program need not continue forever to generate permanent

emissions reductions. Such reductions can be discrete or continuous,

depending on the nature of the program. Discrete (i.e., temporary)

reductions can be used to defer but not solely to satisfy continuous

emission reduction requirements (e.g., RACT).

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This notice identifies key program provisions which must generally

be included to ensure that the above requirements will be met. Adequate

program designs will generally include the following elements: Clearly

defined goals and an incentive mechanism that can be rationally related

to accomplishing the goals; a clearly defined scope, which identifies

affected sources and assures that the program will not interfere with

any other applicable Federal regulatory requirements; a program

baseline from which projected program results (e.g., quantifiable

emissions reductions) can be determined; credible, workable, replicable

procedures for quantifying emissions and/or emission-related

parameters, as appropriate; source requirements, including those for

MRR, that are consistent with specified quantification procedures and

allow for compliance certification and enforcement; requirements for

projecting program results and dealing with uncertainty; and an

implementation schedule, administrative system, and enforcement

provisions adequate for ensuring Federal and State enforceability of

the program. All EIP's for which SIP credit is taken in attainment and

RFP demonstrations must include additional elements, such as audit

procedures to evaluate program implementation and track results, and,

in certain cases, reconciliation procedures to trigger corrective or

contingency measures to make up any shortfall between projected

emissions reductions and emissions reductions actually achieved in

practice.

The rules are, of necessity, general in nature with regard to

criteria for designing adequate program elements. This generality

arises due to the large variety of EIP types and designs which may be

submitted, and the Agency's goal of encouraging creativity and

innovation on the part of the States developing such programs. There

are three broad, interrelated aspects of any program design that

significantly affect the approvability of an EIP: How the EIP relates

to other SIP provisions, the level of certainty in quantifying

emissions and projecting EIP results, and the nature and extent of MRR

requirements for enabling determinations of compliance. For example,

today's notice reflects the Agency's view that the scope and nature of

MRR requirements, including the extent to which an EIP exceeds the

minimum requirements for such, would be among the factors to be

considered in assessing the adequacy of any demonstration of projected

EIP program results. The Agency anticipates preparing additional

guidance on specific aspects of program design as it gains experience

with EIP's, partly through participation in feasibility and

demonstration projects.

Descriptions of a broad range of general types of incentive

strategies which exemplify potential EIP's are appended to the final

rules. These descriptions identify key provisions which distinguish the

different model program types. These examples are general in nature so

as to avoid limiting innovation on the part of the States in developing

programs tailored to individual State needs. The EPA has placed in the

docket support documents which survey a wide range of EIP's that have

actually been implemented, as well as programs in the design stage. The

EPA has also issued information and guidance, as required by section

108(f)(1)(A) of the Act, regarding the formulation and emissions

reductions potential of various transportation control measures

(TCM's).3

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\3\Further information on potential TCM's and other mobile

source measures is also contained in a staff memorandum,

``Preliminary Mobile Source Economic Incentive Program Strategies,''

from P. Okurowski to P. Lorang, March 30, 1992, which is available

in the docket.

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The EPA also published interim guidance on the generation of

emissions reductions credits (ERC's) from mobile source control

programs at the same time the EIP rule was proposed.4 The EPA

intends to respond to comments received on this interim guidance and

publish final guidance in conjunction with other EIP-related guidance

on ERC banking currently being developed.

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\4\Interim Guidance on the Generation of Mobile Source Emission

Reduction Credits, 58 FR 11134, February 23, 1993. For information

and copies of the associated technical addendum entitled Guidance

for the Implementation of Accelerated Retirement of Vehicles

Programs, please contact: Mr. Mark Simons, U.S. EPA, 2565 Plymouth

Road, Ann Arbor, MI 48105, (313) 668-4417. For information and

copies of the associated technical addenda entitled (1) Guidance for

Emission Reduction Credit Generation by Clean Fuel Fleets and

Vehicles or (2) Guidance for Mobile Emission Credit Generation by

Urban Buses, please contact: Mr. Glenn Passavant, U.S. EPA, 2565

Plymouth Road, Ann Arbor, MI 48105, (313) 668-4408.

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The EPA intends that today's notice be consistent with other

related rules and policies, either in place or under development, such

as the title V operating permits rules, the title VII rules for

enhanced monitoring, general guidance on the implementation of title I,

and policies on emission trading.

II. Summary of Rules and Guidance

A. Applicability

The rules promulgated in today's notice apply to any statutory EIP

submitted to the EPA as a SIP revision to comply with sections

182(g)(3), 182(g)(5), 187(d)(3), or 187(g) of the Act, which either may

or must be adopted by States upon the failure of a State either to meet

or to submit an adequate showing that an applicable RFP or a specific

emissions reductions milestone has been met (in serious, severe, and

extreme O3 nonattainment areas, and serious CO nonattainment

areas), or upon the failure of a serious CO nonattainment area to

attain the NAAQS for CO. The provisions contained in these rules,

except as explicitly exempted, also serve as the Agency's policy

guidance on any discretionary EIP's submitted as SIP revisions.

B. Definitions

The term ``EIP'' is defined to include State established emission

fees, marketable permits, State fees on the sale or manufacture of

products the use of which contributes to O3 formation, TCM's, or

any combination of such measures.

C. State Program Election and Submittal

Under today's rules, statutory EIP's submitted as SIP revisions,

when applicable, must be sufficient, in combination with other elements

of the plan, to achieve the next applicable milestone (for serious,

severe, and extreme O3 nonattainment areas), or to reduce the

total tonnage of emissions of CO in the area by at least 5 percent per

year until attainment is achieved (for serious CO nonattainment areas).

Discretionary EIP's must not interfere with any applicable requirement

concerning attainment and RFP, or any other applicable requirement of

the Act (section 110(l)).

D. State Program Requirements

Today's rules and guidance establish as a goal for all EIP's that

they be designed to benefit both the environment and the regulated

entities. In addition, EIP's must be State and federally enforceable,

nondiscriminatory (with respect to interstate commerce), and consistent

with the timely attainment and maintenance of NAAQS, all applicable RFP

and visibility requirements, applicable prevention of significant

deterioration (PSD) increments, and all other applicable requirements

of the Act. Programs in nonattainment areas for which credit is taken

in attainment and RFP demonstrations shall be designed to ensure that

the effects of the program are quantifiable, and that the credit taken

is limited to that which is surplus to other SIP-credited requirements.

Statutory EIP's must be designed to result in quantifiable, significant

reductions in actual emissions.

A number of program elements are outlined in the rules which must

be included, as applicable, as part of any EIP design. These elements

are required to delineate program scope, to specify credible, workable,

replicable emission quantification procedures and all affected source

requirements, to project program results, to specify audit and, if

appropriate, reconciliation procedures (to evaluate program

implementation, track results, and, as appropriate, trigger corrective

or contingency measures), and to define an implementation schedule,

administrative procedures, and effective enforcement mechanisms.

E. Use of Program Revenues

The rules incorporate statutory restrictions on the use of revenues

generated by statutory EIP's. Specifically, any such revenues may be

used by a State for providing incentives for achieving emissions

reductions, providing assistance (up to 75 percent of the costs) for

the development of innovative technologies for the control of O3

air pollution and for the development of lower-polluting solvents and

surface coatings, and funding (with up to 50 percent of the revenues)

administrative costs of State programs under this Act. These

restrictions on the use of revenues do not apply to discretionary

EIP's.

III. Discussion of Rules and Guidance

This portion of the notice provides more detail on the provisions

of the final rules and guidance.

A. Applicability

The rules published in today's notice apply to any statutory EIP

submitted to the EPA as a SIP revision to comply with sections

182(g)(3), 182(g)(5), 187(d)(3), or 187(g) of the Act, which either may

or must be adopted by States upon the failure of a State either to meet

or to submit an adequate showing that an applicable RFP or a specific

emissions reductions milestone has been met (in serious, severe, and

extreme O3 nonattainment areas, and serious CO nonattainment

areas), or upon the failure of a serious CO nonattainment area to

attain the NAAQS for CO. The provisions contained in these rules,

except as explicitly exempted, also serve as the Agency's policy

guidance on any discretionary EIP's submitted as SIP revisions.

Further, the EPA will use the provisions contained in these rules as

guidance in preparing EIP's, when appropriate, for FIP's necessitated

by State failures and for other Federal measures.

The EPA intends to review EIP's submitted as plan revisions based

on the general SIP review requirements contained in sections 110(k),

110(l), 182, and 187 of the Act, as applicable, and associated Agency

policies. For statutory programs, the Agency intends to review the plan

revision and either approve or disapprove all or part of the revision

within 9 months after the date of the State's submission of the plan

revision, consistent with section 182(g)(3) and 182(g)(5) of the Act.

For discretionary EIP's, Agency action on plan revisions submitted for

review will be taken according to the same schedule as is applicable to

any other type of plan revision. An EIP submitted as a plan revision

will be deemed to be approved only upon an affirmative decision by the

Agency.

B. Definitions

The definitions in today's notice include many terms drawn from the

Act or other regulations or guidance documents, as well as new terms

relating to EIP's. Key new terms are discussed below.

1. Economic Incentive Program

Consistent with section 182(g)(4)(A) of the Act, for purposes of

today's rulemaking, ``EIP'' is defined to mean a program which may

include ``State established emission fees or a system of marketable

permits, or a system of State fees on sale or manufacture of products,

the use of which contributes to O3 formation, or any combination

of the foregoing or other similar measures.'' In addition, the Act

expands this definition to include ``incentives and requirements to

reduce vehicle emissions and vehicle miles traveled in the area,

including any of the transportation control measures identified in

section 108(f).''

For purposes of this rulemaking, this notice classifies EIP's into

three broad categories: emission limiting, market response, and

directionally-sound. This categorization is based on whether a

quantifiable emission-related requirement is directly specified as an

integral element of the program or whether the program depends upon

marketplace decisions, in response to a program's incentive, to produce

the intended emission-related objective of the program. Further, the

categorization is a function of whether the results of the program are

quantifiable.

Emission-limiting strategies directly specify limits on total mass

emissions, emission-related parameters (e.g., emission rates per unit

of production, product content limits), or levels of emissions

reductions relative to a program baseline that are required to be met

by affected sources, while providing flexibility to sources to reduce

the cost of meeting such limits. A marketable permits program (i.e.,

emission trading with source-specific mass emissions limitations, or

caps) is a primary example of such a program. If every affected source

in such a program complies with its emissions cap (taking into account

both emissions generated by the source as well as any emissions

trading), the program will necessarily achieve the specified emissions

limits.

A market-response strategy creates one or more incentives for

affected sources to reduce emissions, without directly mandating

emission-related requirements for individual sources or even for all

sources in the aggregate. An emission fee program may be an example of

a market-response strategy. In such a program, each source might be

required to pay a fee on each unit of emissions. The response to the

incentive, in terms of actions which affect emissions levels, will be

determined by each source according to its abatement opportunities,

costs, and other factors. Thus, each source has flexibility in

determining its ultimate level of emissions (within any constraints

imposed by other regulatory requirements).

A consequence of programs based on market-response strategies is

that actual emissions from affected sources may differ from the pre-

implementation projected emissions level even if every affected source

is in full compliance with the EIP requirements. This added degree of

uncertainty in program results must be accounted for in designing such

a strategy (see paragraph III.D.6.).

Directionally-sound strategies do not yield quantifiable emissions

reductions creditable towards RFP or attainment demonstrations. Such

strategies may be included in an area's attainment plan, without

credit, or in a maintenance plan if the strategy contributes to the

area coming into or maintaining attainment. Emissions reductions from

such programs are not creditable towards RFP or attainment

demonstrations because the program lacks one or more of the basic

program elements, such as a quantifiable program baseline or adequate

emissions quantification procedures. However, a State may want to

pursue such a strategy as a part of their overall program to attain and

maintain the NAAQS. Directionally-sound strategies must not be used as

the primary basis for any statutory EIP submitted pursuant to sections

182(g)(3), 182(g)(5), 187(d)(3), and 187(g) of the Act.

A number of different types of incentive strategies have been

identified upon which EIP's could be based. Appendix X contains

descriptions of different types of strategies, together with a listing

of the TCM's included in section 108(f) of the Act. There is not,

however, in all cases a direct correspondence between a type of

strategy and the regulatory categories described above, since program

design details can in some cases make a difference in the extent to

which program results are quantifiable or dependent on market response.

2. Program Baseline

The determination of a program baseline is the first step in

projecting program results. Results from EIP's can be projected in

terms of quantifiable emissions reductions, or, in the case of

directionally-sound programs, in terms of other emission-related

parameters. Further, some types of incentive strategies depend upon the

establishment of a program baseline, in terms of a level of mass

emissions or emission-related parameter(s), for each affected source or

aggregated overall affected sources, as a starting point for the

incentive program mechanism. For example, a marketable emissions permit

program could be initialized by a program baseline that allocates to

each source a cap on mass emissions that serves as its starting point

for any emissions trading transactions or future emissions reductions

requirements. For other types of programs, this program baseline could

be defined in terms of emission-related parameters, such as average

emission rates, solvent content, or vehicle ridership factors.

3. Nondiscriminatory

Section 182(g)(4) provides that statutory EIP's must be

``nondiscriminatory'' and must be ``consistent with applicable law

regarding interstate commerce.'' The EPA interprets these requirements

to mean that a statutory EIP must not discriminate in favor of

intrastate commerce and against interstate commerce. In addition, an

EIP must meet any other applicable limitations under the Commerce

Clause of the U.S. Constitution. For example, State taxes must meet the

requirements, to the extent applicable to the tax, set out by the U.S.

Supreme Court in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274

(1977). There, the Court stated that a State tax will pass scrutiny

under the Commerce Clause only if ``the tax is applied to an activity

with a substantial nexus with the taxing State, is fairly apportioned,

does not discriminate against interstate commerce, and is fairly

related to the services provided by the State.'' Id. at 279. Under the

EPA's interpretation, Congress did not intend, by the provisions

authorizing EIP's, either statutory or discretionary, to delegate its

authority under the Commerce Clause to the States, and thereby release

State EIP's from the limitations that would apply under the Commerce

Clause had Congress not specifically authorized the EIP; rather,

Congress intended to maintain those limitations.

C. State Program Election and Submittal

The mandated schedules for the development, submittal, review/

approval, and implementation of statutory EIP's, submitted pursuant to

sections 182(g)(3), 182(g)(5), 187(d)(3), and 187(g) of the Act, may

leave as little as 6 months for the EIP to be operational prior to the

next milestone requirement. Thus, in these cases, the time available to

develop, implement, and achieve emissions reductions from an EIP will

be extremely limited if a State waits until a milestone failure occurs

to initiate the selection and development of a statutory EIP. As a

result, the EPA encourages States to initiate development of an EIP as

soon as they determine that a milestone failure is likely, or even

sooner, as part of their SIP.

States are encouraged to consider inclusion of discretionary EIP's,

where appropriate, in the SIP's (or SIP revisions) due within the first

4 years after enactment of the amended Act (e.g., sections 182 (b)(1)

and (c)(2), 187(a)(1)). Submittal at that time would more likely allow

sufficient time to develop, implement, and evaluate the effectiveness

of the program. If such an early EIP submittal is made, States must

account for the effects of the EIP in any subsequent required SIP

submittals. Nothing in today's notice precludes a State from revisiting

and amending its original EIP, or any other pre-existing rules, as

necessary, to ensure consistency with any subsequent required SIP

submittals.

The requirements of section 182(g)(3) and 182(g)(5) of the Act

apply any time that a State fails to submit an adequate milestone

compliance showing, or when the EPA determines that a milestone has

been missed by an area covered by these provisions. For example, if

such a milestone is not met by a serious or severe O3

nonattainment area, the area may elect among three options, including

an EIP. The Act does not provide any additional or different

requirements that would apply when a State that missed one milestone,

and makes a proper election, misses a subsequent milestone.

Accordingly, if a subsequent milestone is missed, the same choices are

available, including the election of an EIP. Thus, the imposed

requirements or specified options apply not only the first time that a

milestone is missed, but also if subsequent milestones are missed even

if an EIP had previously been implemented. Similarly, the EPA

interprets section 187(g) (requiring serious CO nonattainment areas

that fail to attain to adopt an EIP) as applying even if the area

previously missed a milestone and adopted an EIP pursuant to section

187(d)(3). A second missed-milestone program must provide reductions

beyond the reductions from a first statutory program. The second EIP

may either be a new program or a substantive revision of the first

program.

D. State Program Requirements

Under today's rules, EIP's must be State and federally enforceable;

nondiscriminatory (with respect to interstate commerce); and consistent

with the timely attainment and maintenance of NAAQS, all applicable RFP

and visibility requirements, applicable PSD increments, and all other

applicable requirements of the Act. Programs in nonattainment areas for

which credit is taken in attainment and RFP demonstrations shall be

designed to ensure that the effects of the program are quantifiable and

that the credit taken is limited to that which is surplus to other SIP-

credited requirements. Statutory EIP's must be designed to result in

quantifiable, significant reductions in actual emissions.

Each of the program elements that must be included, as applicable,

in an EIP submitted to the EPA as a plan revision are described below.

For EIP's that allow trading to meet existing source requirements, the

EPA will consider a two-step process for State submittal and EPA review

of the program elements outlined below. Under such a step-wise process,

the initial submittal shall include both a framework for all the

general elements of program design, as well as all the specific

regulatory details for a source-specific trade or for an entire source

category, which trade or source category is representative, with

respect to all program elements, of the types of trading to be allowed

under the general framework. For example, for an EIP designed to

directly implement trading within source categories, the initial

submittal shall include the full details of all program elements for at

least one source category. Alternatively, for an EIP designed to

implement trading on a source-by-source basis, with EPA review of each

trade, the initial submittal shall include the full details of all

program elements for at least one source-specific trade. Thus, required

specific aspects of the emission quantification procedures and MRR

requirements for additional sources and/or source categories could be

submitted at a later time to allow the State to phase-in the

application of the program to other individual sources or source

categories. Because adequate enforceability elements--including

emissions quantification procedures, test methods, and MRR

requirements--are integral to any SIP program, approval by the EPA of a

framework for trading would constitute approval only of the framework

elements included as part of the initial submission and of trading for

those sources or within those source categories submitted with the

framework and approved for trading by the EPA. Trading involving other

sources or source categories could not occur until all elements,

including enforceability elements, were approved by the EPA through a

subsequent step in the process. The EPA will apply the same criteria in

reviewing step-wise submittals of emission quantification and MRR

requirements as in reviewing such requirements submitted together with

the other program elements. Thus, a subsequent submittal must be fully

compatible with all the elements in the initial submittal, and, taken

together, both submittals must meet all the requirements of the EIP

rules and guidance. The EPA does not intend to consider use of this

step-wise process for EIP's that mandate new requirements for affected

sources (e.g., requiring mass emission caps on sources previously

required to meet emission rate limits).

1. Program Goals and Rationale

An acceptable EIP must clearly define the goals of the program and

provide a rationale relating how the program design will accomplish the

goals. These final rules and guidance establish as a goal for all EIP's

that they be designed to benefit both the environment and the regulated

entities. The final rules and guidance require States to design

programs that will meaningfully meet this goal, while providing

flexibility to the States to determine how best to accomplish such

``benefits sharing'' in the context of each specific program.

The term ``benefits'' is broadly defined to include not only

economic benefits, such as cost savings and compliance flexibility for

the regulated sources, but also environmental benefits that will result

in States reaching attainment of the NAAQS faster than might otherwise

occur solely through the use of traditional strategies. Environmental

benefits can be created most directly by EIP's that require increased

or more rapid emissions reductions beyond those that would be achieved

through a traditional regulatory program. Specifically, a 10 percent

increase in emissions reductions would presumptively meet this benefits

sharing goal. Alternatively, environmental benefits can also be

achieved by programs that incorporate, for example, improved

administrative mechanisms (e.g., that achieve emissions reductions from

sources not readily controllable through traditional regulation),

reduced administrative burdens on regulatory agencies that result in

increased environmental benefits through other regulatory programs,

improved emissions inventories that enhance and lend increased

certainty to State planning efforts, and the adoption of emission caps

which over time constrain or reduce growth-related emissions beyond

traditional regulatory approaches.

Statutory EIP's will benefit the environment as a result of the

requirement that they be designed to result in significant reductions

in actual emissions. For discretionary EIP's, no standard formula for

benefit sharing is specified, although the EPA encourages States, to

the extent practicable, to design such programs so as to create most

directly increased or more rapid emissions reductions (see paragraph

IV.A.2).

The EPA notes that any incentive-based program has the potential to

create incentives for pollution prevention and technological

innovation. Such an inherent potential benefit can only meaningfully

meet the goal of providing benefits to the environment if the program

is specifically designed to allocate some of the effects of such

innovation to enhancing environmental progress. Likewise, for the other

ways listed above in which environmental benefits can be accomplished,

the EPA intends that these approaches be meaningfully implemented so as

to produce real environmental benefits.

A well-designed EIP will achieve a number of different kinds of

environmental benefits. For instance, a marketable emissions permit

program, with mass emissions caps declining over time, may achieve

several results. The declining cap aspect of the program can result in

real emissions reductions creditable towards RFP milestones and

attainment (to the extent that actual emissions are reduced). The

marketable aspect of the program allows emission sources facing

differing costs of further emission control to trade, lowering overall

control costs. Such programs also encourage sources already able to

meet their mass emissions caps to find ways of further reducing

emissions beyond what would otherwise be required by traditional

regulatory programs (e.g., through pollution prevention, technological

innovation, or changes in operational procedures).

Statutory EIP's, submitted because of failures in achieving

required emissions reductions, must make a significant contribution to

the required reductions, while not necessarily bearing the full burden

of achieving all the required reductions or mandating any specific

percentage reduction. A program producing no additional emissions

reductions or one based solely on a directionally-sound strategy,

without quantifiable benefits, would not satisfy these criteria for an

acceptable statutory EIP. For discretionary EIP's, the final guidance

relies upon the new State planning, quantitative progress, and

attainment requirements in the Act to ensure expeditious attainment of

the NAAQS, regardless of the type of programs that States may choose to

include in their SIP's.

Any EIP should include a rationale for how the incentive

mechanism(s) will achieve the stated goal(s). A State can create a

better overall program design by carefully examining and explaining the

linkage between a program's provisions and the desired outcome. The

provisions of a program must be sufficient to ensure the program goals

are successfully achieved without creating unintended detrimental side

effects.

2. Program Scope

As with any regulatory program, an EIP must identify the affected

sources covered by the program. The affected sources may be defined on

the basis of source type (e.g., manufacturing operations), activity

type (e.g., fuel storage tanks), location, firm size, quantity of

emissions, or other such characteristics. In addition, a State may

choose to grant exemptions from program requirements to sources meeting

specified criteria. For example, States may consider exempting zero-

emitting vehicles from a new parking price program. In establishing the

affected source criteria, a State must assure that the resultant

program is nondiscriminatory within the meaning given that term in

these rules.

The program must establish procedures for dealing with sources

entering or exiting affected source categories. In order to promote

economic growth consistent with achieving environmental goals, a

regulatory program should not create unwarranted barriers to entry for

new or expanding business entities.

In addition, the program must establish criteria and procedures for

sources voluntarily choosing to opt-in to or to be exempted from the

program, to the extent that the program design allows for such movement

into or out of the universe of affected sources. For example, the title

IV acid rain allowance trading program includes provisions for sources

not originally in the program to opt-in to the program in order to sell

sulfur dioxide (SO2) emission allowances to sources already in the

program. Certain EIP's may also provide criteria for exempting sources

such that they can leave the program; such criteria must be described

and the procedures for leaving the program must be included in the EIP.

Any such procedures must ensure that movement into or out of the

program will not interfere with other statutory requirements nor result

in an increase in area-wide emissions that is not reflected in the

plan's attainment or RFP demonstrations. Finally, the opt-in program

language must specify that it will not allow sources to opt-in if the

net result of the opt-in program as a whole is to increase area

emissions, unless such increase has been accounted for in the

development of the EIP, and is consistent with attainment and

maintenance of the NAAQS, RFP, and all other SIP requirements.

Affected sources in an EIP may also be covered by other Federal

regulatory requirements. An EIP may not interfere with applicable

requirements concerning attainment and RFP, or any other applicable

requirements of the Act. Thus, the program scope must be defined so as

not to interfere with any other Federal regulatory requirements which

apply to the affected sources. Such requirements for stationary sources

may include, but are not limited to, reasonably available control

technology (RACT), PSD and new source review (NSR) offset requirements,

lowest achievable emission rate (LAER), best available control

technology (BACT), new source performance standards (NSPS), national

emissions standards for hazardous air pollutants (NESHAP's), acid

deposition program requirements, reasonably available control measures

(RACM), and best available control measures (BACM). Such requirements

for mobile sources may include, but are not limited to, programs

integral to vehicle inspection and maintenance (I/M), clean-fueled

fleets, reformulated gasoline, oxygenated fuels, employee commute

options (ECO), TCM's, and Federal motor vehicle controls.

In general, sources subject to these statutory requirements may

participate in emissions trades pursuant to an EIP as long as, apart

from their participation in such trades, they continue to meet the

statutory requirements. Thus, if these sources reduce their emissions

below what the applicable statutory requirements call for, the

reductions beyond the requirements may furnish credits for the

EIP.5 Following is a more specific discussion of the interplay of

the EIP rules with several of the statutory provisions listed above.

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\5\For example, since VOC reductions that occur as a result of

controls put in place to meet NESHAP's are creditable to RFP, such

VOC reductions cannot be considered as surplus to supply VOC credits

through an EIP. However, if in such a case greater than required

reductions are made, the incremental VOC reductions could furnish

credits through an EIP.

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RFP Requirements. Credits for emissions reductions from stationary,

mobile, or area sources may generally be used to meet the ``progress''

requirements of the nonattainment provisions of the Act. The SIP's for

O3 nonattainment areas classified as moderate or higher under

section 181(a)(1) are required to provide for reductions in volatile

organic compounds (VOC) of at least 15 percent from baseline emissions

by 1996, and areas classified as serious or higher are required to

provide for reductions of at least 3 percent each year (averaged over a

3-year period) thereafter until the attainment date (section 182(b)(1),

182(c)(2)(B)). Emissions reductions from all sources may be used to

meet these progress requirements, except for those reductions

attributable to Federal motor vehicle programs and RACT and NSR

corrections (section 182(b)(1) (C)-(D)).

RACT. An EIP may allow sources subject to the RACT requirement to

attain RACT-level emissions reductions in the aggregate, and thereby

trade among themselves. In designing such RACT trading programs (to

implement new and/or previously existing RACT requirements), as with

any EIP, States are encouraged, to the extent practicable, to meet the

benefits sharing goal directly, by requiring increased emissions

reductions beyond those that would be achieved through a traditional

RACT program.

In addition, today's rules and guidance authorize emissions trading

between the stationary sources subject to the RACT requirement (``RACT

sources'') and any sources (i.e., stationary, mobile, and area sources)

not subject to the RACT requirement (``non-RACT sources'') when such

trading results in an exceptional environmental benefit, e.g., a level

of reductions that is significantly greater than RACT-level amounts.

With respect to the level of emissions reductions required from the

non-RACT sources, the appropriate amount of emissions reductions

generally should be set at a level that takes into account the severity

of the nonattainment status in a given area.

Today's rules establish the statutory offset ratios for

nonattainment areas as the determinant of the amount of emissions

reductions that would be required from non-RACT sources generating

credits for RACT sources. The offset ratios are lower for lower-

classified areas (e.g., compare section 182(a)(4), with a 1.1 to 1

offset ratio for marginal areas, and section 182(d)(2), with a 1.3 to 1

offset ratio for severe areas). Looking to offset ratios is instructive

because offsets are an aspect of emissions trading that is directly

addressed in the Act. The offset ratios provide a suitable analogy

because they represent the most substantial benefit to the environment

for a given area that is required in this statutory context of

emissions trading.

However, today's rules authorize emissions trading between RACT and

non-RACT sources at less than the offset ratios if exceptional

environmental benefits are otherwise demonstrated, such as, for

example, an emissions trade that promoted the market penetration of

emissions reduction measures for non-RACT sources, such that future

emissions reductions from the universe of non-RACT sources would be

expected to increase over time. Such measures could include new vehicle

technologies that utilize alternative fuels, provided that such

technologies meet all relevant EPA standards and guidelines. Where a

lower trading ratio is authorized in order to promote the market

penetration of an environmentally-beneficial, new control measure, a

lower bound for the trading ratio of 1.1 to 1 will assure that in all

events some additional benefit will accrue to the environment. In

setting the appropriate ratio for trades between RACT and non-RACT

sources, States may also take into account additional State and

federally-enforceable emissions reductions that are achieved as a

result of other exceptional environmental features of an EIP (such as a

separate ``environmental bonus'' provision, as discussed in EPA's

Interim Guidance on the Generation of Mobile Source Emissions Reduction

Credits). In no case, however, can a trading ratio be lower than 1 to

1, and in no case can the effective trading ratio be less than the

appropriate offset ratio (or such ratio, as low as 1.1 to 1.0, as may

be authorized to promote the market penetration of environmentally-

beneficial, new control measures).

Offsets. Credits for emissions reductions generated by stationary,

mobile, or area sources may be used for purposes of meeting the offset

requirement for major new and modified sources in nonattainment areas

so long as they meet the restrictions imposed on offsets by section 173

of the Act and the EPA's new source review regulations (40 CFR 51.165

and part 51, appendix S). Under the nonattainment provisions, new or

modified major stationary sources may not receive permits for

construction and operation in a nonattainment area unless, among other

things, their new emissions are offset by reductions from other sources

in the area (section 172(c)(5), 173(a)(1)(A)). For O3

nonattainment areas, minimum offset ratios range from 1.1 to 1 for

marginal areas to 1.5 to 1 for extreme areas (section 182(a)(4),

182(b)(5), 182(c)(10), 182(d)(2), 182(e)(1)).

However, the Act does not require that offsets be secured by the

new source. Rather, any portion of the necessary offsets may be

generated by the local air quality district or by the State. In other

words, a jurisdiction may set up an offset ``bank'' to supply new

sources with sufficient emissions reductions to satisfy their offset

obligations. To satisfy the requirements set forth in section 173, each

time a new source commences operations, the jurisdiction must have

already generated the necessary emissions reductions to offset the new

emissions. This means that the jurisdiction must be able to demonstrate

that the program has secured sufficient excess emissions reductions to

offset all new emissions at the proper ratio. If the source itself is

only held responsible for securing emissions reductions in an amount

equal to its new emissions (i.e., a 1 to 1 ratio), the SIP must

generate sufficient reductions to cover the extra reductions required

(e.g., 1.2 to 1 in serious O3 nonattainment areas).

The Act limits offsets to emission reductions not ``otherwise

required by this Act.'' As part of the ``General Preamble for the

Implementation of Title I of the Clean Air Act Amendments of 1990,''

the EPA described certain circumstances under which reductions would

not be creditable for offset purposes because those reductions are

required by other provisions of the Act (57 FR 13498, 13553 (April 16,

1992)). In addition, the EPA intends to provide additional guidance

regarding offsets in the near future.

BACT and LAER. Both the PSD program and the nonattainment NSR

program contain technology-based emission limitations that are source

specific. The Act expressly requires that these emissions limitations

(i.e., BACT in the case of PSD and LAER in the case of NSR) be met by

the proposed major new source or major modification itself as a

condition of permit issuance. Consequently, neither of these

requirements can be met through emissions trading.

Regarding BACT, section 165(a) of the Act provides that no major

new source or major modification may be constructed in a PSD area

unless the requirements in section 165(a)(1)-(8) are met. Section

165(a)(1) specifies that among these requirements is ``a permit * * *

setting forth emission limitations for such facility which conform to

the requirements of this part.'' Section 165(a)(3)(C) further specifies

that the proposed facility must demonstrate that emissions from the

facility will not exceed any applicable emission standard under the

Act.6 The applicable emissions limitations are those provided in

section 165(a)(4), which provides that the proposed facility must ``be

subject to the best available control technology for each pollutant

subject to regulation under this Act emitted from, or which results

from, such facility.''7

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\6\Section 302(k) of the Act defines the terms ``emission

limitation'' and ``emission standard'' interchangeably.

\7\Section 169(3) in turn defines BACT as ``an emission

limitation based on the maximum degree of reduction of each

pollutant subject to regulation under this Act emitted from or which

results from any major emitting facility, which the permitting

authority, on a case-by-case basis, taking into account energy,

environmental, and economic impacts and other costs, determines is

achievable for such facility.''

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The Act sets forth a similar statutory scheme with respect to LAER.

Section 173(a) provides that the permit program applicable to major new

sources or major modifications, which is required to be included in

part D SIP's under section 172(b)(5),8 shall provide that permits

to construct and operate may be issued only if the requirements set

forth in section 173(a)(1)-(5) are met. Among these enumerated

requirements is section 173(a)(2), which specifies that ``the proposed

source is required to comply with the lowest achievable emission

rate.''9

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\8\Section 173(a) incorrectly refers to the ``permit program

required by section 172(b)(6).'' Section 172(b)(6) was renumbered as

section 172(b)(5) by the 1990 Amendments. Apparently, this change

was not picked up by the drafters of revised section 173.

\9\Section 171(3) defines LAER as ``that rate of emissions which

reflects'' either ``the most stringent emission limitation which is

contained in (any SIP) for such class or category of source,'' or

``the most stringent emission limitation which is achieved in

practice by such class or category of source, whichever is more

stringent.''

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The statutory provisions addressing both BACT and LAER clearly

require the permitting authority to set, and the source owner to comply

with, the applicable technology-based emission limitation. There is no

provision in the statute for lawfully complying with BACT or LAER

through obtaining emissions reductions at other sources that would

result in an equivalent reduction of emissions or ambient

concentrations.

Inspection and Maintenance Programs. The I/M provisions of the Act

require a vehicle I/M program that meets specified performance

standards. The requirements of the I/M provisions cannot be met by

obtaining ERC's from sources other than vehicles, or from vehicles

through means other than I/M of the vehicle. An EIP may not substitute

entirely for an enhanced or basic periodic vehicle I/M program.

This view is based on the provisions of the Act that set forth

requirements for a basic I/M program, as well as certain provisions

relating to enhanced I/M programs. Sections 182(a)(2)(B)(i) (I/M ``fix-

ups'' for O3 nonattainment areas classified marginal and higher),

182(b)(4) (I/M ``catch-ups'' for O3 nonattainment areas classified

moderate and higher), and 187(a)(4) (I/M ``fix-up'' requirement for CO

nonattainment areas classified moderate and higher) each require a SIP

revision that includes provisions for a ``vehicle inspection and

maintenance program'' that meets a specified performance standard.

The provision for an enhanced I/M program for CO nonattainment

areas classified as moderate and with a design value higher than 12.7

ppm, or classified as serious, requires the SIP to include provisions

for ``an enhanced vehicle inspection and maintenance program as

required in section 182(c)(3) (concerning serious O3 nonattainment

areas)'' (section 187(a)(6)). This provision confirms that the required

I/M program is in fact a vehicle I/M program. The primary provision for

an enhanced I/M program for O3 nonattainment areas classified as

serious or higher does not include a comparable ``inspection and

maintenance'' phrase (i.e., requires the SIP ``to provide for an

enhanced program to reduce hydrocarbon emissions and nitrogen oxides

(NOX) emissions from in-use motor vehicles''), but it further

includes specific requirements for various types of testing,

inspections, etc., that make clear that the program must obtain

reductions from vehicle I/M (section 182(c)(3)).

Nevertheless, both the basic I/M program and the enhanced I/M

program requirements authorize a substantial degree of flexibility in

program design. The Act directs the EPA to require a specific amount of

emissions reductions, but also authorizes the State to design the

program in a manner that meets the EPA established performance standard

through different means. The EPA's final rule on I/M programs describes

the EPA's performance standards and the ways that States can meet those

standards (57 FR 52950-53014). In so doing, the State can take

advantage of economic efficiencies (e.g., have a better test on more

older cars to get greater performance, in exchange for some relaxation

in another element). In addition, States could address mal-maintenance

in the vehicle fleet in part by including an old car scrappage program

as an element of the overall package used to meet the performance

standard. However, the SIP must include a program obtaining the

required reductions through vehicle inspections.

3. Program Baseline

An EIP baseline must be fully defined within the EIP, and used as a

basis for projecting program results and, if applicable, for

initializing the incentive mechanism. States have flexibility in

defining the program baseline for EIP's that implement new RACT

requirements for previously unregulated source categories through

trading programs, as long as the new RACT requirements reflect, to the

extent practicable, increased emissions reductions beyond those that

would be achieved through a traditional RACT program. States may also

use a flexible baseline for EIP's that allow trading with respect to

newly imposed RACT requirements on previously unregulated sources in a

previously regulated source category (e.g., sources newly covered by

lower applicability cut-offs), as long as the EIP, in the aggregate,

yields reductions in actual emissions at least equivalent to those

which would result from source-by-source compliance with the existing

RACT limit for that source category. This requirement can be satisfied

by using existing data on actual and allowable emissions from the

previously regulated sources in the affected source category (see

paragraph IV.C.).

A State also has flexibility in defining the program baseline for

any EIP submitted in conjunction with, or subsequent to, the submission

of any complete areawide progress plan due at the time of EIP submittal

(e.g., the 15 percent RFP plan (section 182(b)(1)) and subsequent 3

percent plans (section 182(c)(2))), and/or an attainment demonstration.

In all such cases, the flexible program baseline may be based on

actual, allowable, or some other intermediate10 or lower level of

emissions, provided the State demonstrates that the program baseline is

consistent with and reflected in the associated RACT rule, progress

plans, or attainment demonstration. Further, for EIP's submitted prior

to the submittal of a required progress or attainment demonstration,

the State must include with its EIP submittal a commitment that its

subsequent attainment demonstration and all future progress plans will

be consistent with the EIP baseline in effect at that time, as well as

a discussion of how the baseline will be integrated into the State's

attainment demonstration. Further, in this discussion, the State should

take into account the potential that emission reduction credits issued

prior to the attainment demonstration may no longer be surplus relative

to the attainment demonstration.11

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\1\0A typical intermediate baseline may consist of a SIP-

allowable emission rate and an actual level of production.

\1\1For example, the State could establish an escrow account or

a formula for pro rata reductions of credits to cover credits that

subsequently are no longer surplus.

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Conversely, for EIP's that do not meet the above conditions

relating to RACT and progress requirements, the program baseline must

be set no higher than the lower of actual or allowable emissions.

Actual emissions are to be taken from the most appropriate inventory,

such as the 1990 actual emission inventory (which was due for

submission in November 1992), and allowable emissions are the lower of

SIP allowable emissions or the level of emissions consistent with

source compliance with all Federal requirements related to attainment

and maintenance of the NAAQS.

In addition, following submission of an EIP that incorporates a

flexible baseline, if the State fails to submit a complete attainment

demonstration, or if the EPA disapproves the attainment demonstration

on the grounds that it does not provide for attainment of the NAAQS,

the EPA may require the State to incorporate in the EIP a program

baseline set no higher than the lower of actual or allowable emissions.

The baseline for an EIP submitted in conjunction with an attainment

demonstration must be consistent with the assumptions employed in the

attainment demonstration, including the location of emissions assumed

in the photochemical grid modelling, if applicable.

In considering emissions trading, the EPA continues to focus on the

aspect of trading that involves the relaxation of a control requirement

on a particular emissions-producing unit (the credit-receiving unit).

Under trading programs, this relaxation is offset by tightening the

control requirements on another emissions-producing unit (the credit-

generating unit). Under section 110(l), this relaxation is authorized

only if it, taken in conjunction with the tighter control requirements,

does not interfere with the ability of the SIP to meet the various

requirements of the Act--most importantly, for present purposes, the

RACT requirement and the requirements for progress (e.g., for RFP in

O3 nonattainment areas, 15 percent reductions in VOC emissions by

1996; and 3 percent-per-year over each 3-year period until the

attainment date), as well as attainment requirements. It is understood

that when the credit-generating unit's actual emissions are below the

level mandated by the applicable control requirement, relaxing a

control requirement on the credit-receiving unit in exchange for

tightening the requirement on the credit-generating unit may result in

an increase in aggregate actual emissions. Under these circumstances

(i.e., trading from an allowables baseline), the relaxation and its

resulting increase in actual emissions could, in some circumstances,

jeopardize RFP and attainment.

As described above, notwithstanding the chance of actual emissions

increases, EIP's may authorize trading from an allowables baseline when

the EIP is submitted in conjunction with, or following, the submission

of the applicable progress plans, and the allowables baseline is

consistent with those plans. Under these circumstances, trading on the

basis of allowables would not jeopardize the progress requirements. In

some cases, the EPA will permit trading to occur on the basis of

allowables prior to submission of the attainment demonstration SIP.

However, once the State has submitted any applicable progress plans due

at the time of EIP submission, the State has made significant progress

towards attainment. This significant progress, coupled with the

sanctions provisions that provide strong safeguards that the State will

develop a SIP requiring any subsequent progress plans and an attainment

demonstration, provide, in the EPA's judgment, sufficient evidence that

an EIP authorizing an allowables baseline submitted in conjunction with

an applicable progress plan will not jeopardize continued progress or

attainment. In addition, States and sources should be aware that any

emission limit relaxations approved through an EIP may be subject to

ongoing scrutiny, and further tightening, if it is unexpectedly

necessary to do so as part of an attainment demonstration.

In addition, as described above, the EPA will permit EIP's that

authorize trading from an allowables baseline in the case of source

categories, or portions of source categories, that are newly subjected

to the RACT requirement under the RACT ``catch-up'' provisions of

section 182(b)(2). Under these circumstances, the imposition of RACT-

level controls meets the RACT requirement, as described above, and is

expected to result in emissions reductions with respect to the affected

source categories or sources taken as a whole, even if some of the

affected sources conduct emissions trades based on allowables. The fact

that overall emissions from these source categories or sources will be

reduced indicates that with respect to these source categories,

progress is being made towards attainment. This progress provides

adequate assurance that any such trades on an allowables basis will not

jeopardize progress or attainment requirements.

If a SIP does not include a required RACT emission limit for a

source, that source may not participate in an EIP until an appropriate

RACT limit is determined.

The provisions described above apply as well in the case of a

statutory EIP. That is, under the circumstances described above, a

statutory EIP may incorporate a flexible baseline as long as the EIP as

a whole provides the required reductions.

A State may define a program baseline to address a variety of

equity considerations, such as differing degrees of emission control

among affected sources prior to the start of the EIP. While emissions

reductions creditable towards a specific required demonstration will be

calculated according to the requirements for that demonstration, the

EIP may use a different baseline. For example, a declining value

marketable permits program, submitted in conjunction with an areawide

RFP or attainment plan, could initially allocate mass emissions caps on

the basis of allowable emissions. However, to the extent that such a

program baseline exceeds the aggregate actual emissions for the sources

covered by the program, the EIP baseline allocation would be required

to decline at a rate consistent with achieving the areawide RFP

milestone as measured against the RFP baseline.

The EIP must clearly specify whether the program baseline applies

to aggregate emissions from all affected sources (similar to the RFP

baseline) or to individual sources (similar to source-specific LAER

requirements, for example). If historic emissions are relevant in

setting the program baseline, the time period must be specified in the

program. Provisions must be made for determining baselines for sources

not active during the specified baseline time period. Also, the

averaging time associated with a program baseline for emissions must be

specified.

4. Quantification Procedures

An EIP must describe how emissions and changes in emissions will be

quantified for SIP credit. If other measurable factors are essential to

an EIP, the quantification procedures for those must be specified in

the program. For instance, if emissions reductions are generated by

reducing total usage of a type of solvent, procedures for measuring

solvent usage are critical. The program must specify the minimum

required credible, workable, replicable procedures for quantifying

emissions, which could include emission factor calculations, direct

emission monitoring, calculation procedures which are a function of

process parameters, production practices or volume, or inventory usage,

or other procedures, as appropriate. Criteria for selecting

quantification methods and time-averaging considerations are discussed

below.

States must carefully consider matching their environmental goals

with various aspects of the program when determining adequate

quantification procedures. For example, a procedure wholly adequate for

determining compliance with long-term mass emissions caps may be

clearly inadequate for a program aimed at limiting peak daily

emissions.

An EIP must establish procedures for quantifying emissions

reductions arising from sources that shut down or curtail production. A

State may not take credit for such emissions reductions as part of an

EIP if the same reductions have already received credit in the SIP's

attainment or RFP demonstrations. For example, SIP demonstrations may

include assumptions about equipment turnover rates and normal operating

levels which may already credit some assumed rate of source shutdowns

and curtailments. Credit also cannot be taken for shutdowns or

curtailments that do not result in a decrease in an area's aggregate

emissions. Changes in emissions at one source may merely increase

emissions at another. For example, if one retail operation goes out of

business, the total level of retail business will not necessarily

change. Instead, customers may shift their business to other merchants

in the area. The effect on aggregate emissions of such ``demand

shifting'' will depend upon the nature of the business, and should be

considered in the design of the EIP.

An EIP also must establish procedures for quantifying emissions

from sources with uneven emission patterns due to batch, seasonal or

cyclical operations. The appropriate procedure for handling these

expected fluctuations in emissions will depend in part on the emissions

averaging time upon which the EIP is based.

The EPA recognizes that the development of quantitative procedures

for mobile sources can present significant challenges. Such procedures

must consider, as appropriate, the factors which will affect or

determine the level of participation in a transportation program, as

well as how much and where vehicles are driven. Such procedures should

clearly address how double-counting will be avoided across various

mobile source programs (e.g., not double-counting I/M program

reductions in quantifying credits from an accelerated vehicle scrappage

program). Any assumptions or models which States may use to predict

behavioral modifications as a result of the implementation of an

economic incentive strategy must be presented as support information

with the EIP submittal. The EPA views the development of sound

incentive-based mobile source programs as an opportunity for the design

of better, more rigorous tools for accounting for and encouraging

mobile source emissions reductions beyond those required by traditional

programs.

The final rules allow for long-term averaging, while requiring that

States make statistical showings that any such averaging is consistent

with applicable RACT, RFP, and short-term NAAQS. Any State that wishes

to use long-term averaging must include, with the plan revision

submittal, a statistical showing that the aggregate effect of the

specified averaging time is consistent with attaining the O3 NAAQS

and satisfying applicable RFP requirements on the basis of typical

summer day emissions; and, if applicable, a statistical showing that

aggregate daily emissions from all affected sources covered by a

Federal RACT requirement (net of any RACT/non-RACT trades) are no

greater than the aggregate daily emissions from such sources that would

result from the implementation of all applicable source-specific RACT

requirements (see paragraph IV.D.2.).

5. Monitoring, Recordkeeping and Reporting

Each affected source in an EIP must comply with requirements

imposed by the program, and must implement the MRR procedures necessary

to assure compliance with such requirements and to provide State and

Federal enforceability. Requirements imposed by an EIP could include

meeting mass emissions limits (either directly or through trading

marketable permits), paying an emission fee, using specified products

or procedures, providing product content labeling, or other measures

specified by the program. Thus, the final rules allow for a wide range

of alternative MRR procedures that provide sufficiently reliable and

timely information for determining compliance. Criteria to be

considered in the development of such procedures include

representativeness, accuracy, precision, reliability, frequency, and

timeliness.

All source-specific program requirements must be structured in such

a way that both inspectors and facility owners can judge the compliance

status of a facility at any time, or, in the case of long-term

emissions limits, at the end of the compliance period. This will

require an authoritative, reliable repository of all relevant

information at each facility.

6. SIP Creditability and Audit/Reconciliation Procedures

A SIP revision that contains an EIP must include projections of the

emissions reductions the State expects to achieve through the

implementation of the program. The projections may be based on

federally-enforceable limits on mass emissions or on other emission-

related parameters, estimates of market response, economic modelling,

or other relevant information. The State does not have to project

emission changes for each source, unless that is how the State chooses

to estimate the emissions reduction from the program. All EIP

submittals must include documentation which clearly states how sources

in an EIP are or will be addressed in the emissions inventory, RFP

plan, and attainment or maintenance plan, as applicable. This

documentation should include a description of the assumptions used in

measuring emissions and emissions reductions from affected sources.

Credit in a nonattainment SIP may be taken for emission limiting

programs (e.g., emissions trading) and market-response programs (e.g.,

emissions fees). Credit may not be taken for directionally-sound

programs until experience with such programs makes quantification

possible, at which time the program could be reclassified into one of

the other categories for which credit may be taken.

For determining SIP credit, the projected emissions reductions must

be adjusted to reflect the uncertainties inherent in EIP's. This

adjustment is currently done for traditional stationary source control

measures through the use of a rule effectiveness factor, developed from

experience with traditional regulatory control programs. For EIP's, the

State must use two uncertainty adjustment factors, as appropriate, to

calculate creditable emissions reductions. The sources of uncertainty

that must be separately addressed are compliance uncertainty (i.e., the

extent to which sources will actually comply with program requirements)

and programmatic uncertainties (e.g., the extent to which voluntary

market responses to incentives actually occur and/or the use of various

quantification methods with differing confidence levels). These sources

of uncertainty must be accounted for through the use of a rule

compliance factor and a program uncertainty factor, respectively.

The State must specify values for rule compliance and program

uncertainty factors, based on program elements such as the

quantification and enforcement procedures, and on the predictive

quality of the information used by the State to develop the projected

emissions reductions. Inherent in the way in which these factors are

defined, the value of either factor must be less than or equal to one.

The State must include with its EIP submittal a justification for the

values assigned to these factors. The State must use these factors in

determining the SIP credit for the program as a whole, or for each

source-specific trade, if appropriate, to ensure that quantification

uncertainties not lessen a source's emissions reductions requirements.

The uncertainty factors should be developed and justified by the State

by taking into account various aspects of the design of the EIP,

including but not limited to, the type of incentive mechanism upon

which the program is based; the variability in emissions from affected

sources and the nature and extent of uncertainty in the emissions

quantification procedures required by the program; the frequency and

type of MRR required by the program; sanctions for noncompliance; the

frequency, scope and committed responses to program audits; and the

nature of administrative procedures to be used by the State in

implementing and enforcing the program (see paragraph IV.F.).

Unless otherwise provided in program-specific guidance issued by

the EPA, EIP's for which SIP credit is taken must also contain program

audit procedures designed to evaluate program implementation and track

program results in terms of both actual emissions reductions and, to

the extent practicable, cost savings realized during program

implementation. The auditing methods and the timing of the audits must

be specified in the EIP. The maximum time interval for conducting such

audits is 3 years, although States are encouraged to consider more

frequent audits. Further, the State must provide timely post-audit

reports to the EPA. For emission-limiting EIP's, program audit

provisions must include a State commitment to ensure timely

implementation of programmatic revisions or other measures which the

State, in response to the audit, deems necessary for the successful

operation of the program (see paragraph IV.G.).

Program audit provisions for market-response EIP's must be

accompanied by reconciliation procedures, designed to compare credited

emissions (i.e., adjusted projected emissions) with actual emissions

achieved through the implementation of the program. The reconciliation

procedures must specify a range of appropriate actions (e.g., invoke

part of a general SIP contingency plan or a program-specific

contingency), revisions to the program requirements (e.g., increase the

fee, include more sources) that will make up for any shortfall between

credited and actual emissions revealed by the audit, or reductions in

the credit taken for the EIP in the SIP (provided that RFP and

attainment requirements continue to be satisfied area-wide based on

such reduced EIP credits in combination with the effects of all other

SIP programs). Such measures must be automatically executing to the

extent necessary to make up the shortfall, with State action required

only to identify which of the specified actions are necessary to make

up the shortfall. Such measures must not require a revision to the

implementation plan to be effectuated once identified by the State;

rather, the measures must be built into the original EIP design (or

incorporated by reference).

Greater burdens should not necessarily be imposed on EIP's,

compared to traditional regulatory programs, by virtue of the audit and

reconciliation requirements. These audit and reconciliation procedures

are consistent with the general approach to implementing the Act being

taken by the EPA, as illustrated in the Agency's rules for vehicle I/

M12 and for reformulated gasoline,13 and in the Agency's

general guidance on the implementation of title I dealing with the rule

effectiveness of stationary source control measures.14 Further, in

appropriate cases, routine ongoing air program management procedures

may be sufficient to fulfill the audit and reconciliation requirements.

In designing audit procedures, the State should consider the relative

uncertainty associated with the EIP and specify the scope and extent of

the audit procedures to be commensurate with that level of uncertainty.

---------------------------------------------------------------------------

\1\2Inspection/Maintenance Program Requirements, 57 FR 52950,

November 5, 1992.

\1\3Regulation of Fuels and Fuel Additives: Standards for

Reformulated and Conventional Gasoline, 59 FR 7716, February 16,

1994.

\1\4Rule Effectiveness Guidance: Integration of Inventory,

Compliance, and Assessment Applications, EPA-452/4-94-001, January

1994.

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7. Implementation Schedule

An EIP must contain a schedule for implementing the program. The

schedule must include dates for notifying potentially affected sources,

as early as possible, about the impending EIP; program initialization

and start-up procedures; compliance and submittal requirements for

affected sources; and audit and reconciliation processes, including

subsequent actions required to make up for any shortfall that occurs.

8. Administrative Procedures

As part of any EIP design, the State must establish appropriate

administrative procedures, specific to the type of incentive strategy,

necessary to implement all of the elements of the EIP. For example, in

a fee program a State must assure the proper administration of the fee

collection process, and if rebate provisions are included, the

administration of the rebate distribution process.

Administrative procedures specific to marketable emissions permit

programs which the State must address in a program design are the

mechanisms required for conducting, approving, verifying, recording,

and tracking trades. The EIP must clearly describe the administrative

system, and any State commitments to implement and maintain the system,

that enables market participants to conduct valid and legally protected

transactions. The State must design the program to ensure that all

program requirements are met by sources involved in trades, such that

the trades result in enforceable changes in allowable emissions levels.

A well-designed EIP will include the minimum amount of transactional

oversight, approval, recording, and tracking provisions necessary to

create a verifiable and enforceable system. Unnecessary or excessive

administrative requirements in a trading system increase the cost of

the program and inhibit trading. An active trading market increases the

opportunities for cost-savings. However, a State must establish

sufficient administrative procedures to ensure that the environmental

goals of the EIP are met, and that the program is adequately

enforceable (see paragraph IV.J.2. and the discussion of emissions

trading markets in Appendix X).

9. Enforcement Mechanisms

An EIP must include adequate enforcement consequences for

noncompliance with any source requirements, including MRR requirements.

Each program must include provisions ensuring that State/local and

Federal statutory maximum penalties preserve the deterrent effect of

traditional regulatory programs. Enforcement provisions should preserve

the criminal sanctions (for knowing violations) authorized in the Act

for violations of SIP requirements per se.

Traditional regulatory programs provide for enforcement against

noncompliance with emissions limits at both the Federal and State/local

levels. The statutory maximum Federal penalties under the Act are

$25,000 per day, per source in violation. To preserve the existing

level of deterrence under the Act, an EIP that imposes multiday and/or

multisource emission limits must define violations of those limits in

such a way that the violations will translate into some combination of

sufficient numbers of violations, sources in violation, and days of

violation. One possible approach would be for the EIP to authorize

predetermined penalties based on the amount of an exceedance of such a

cap, provided the predetermined amounts are sufficiently large (see

paragraph IV.H.).

The EIP's that impose multisource emissions limits must require

facilities to develop enforceable plans for remedying noncompliance in

those cases where facilities have exceeded emissions limits for the

specified averaging period. Such plans must identify appropriate and

enforceable control measures or other procedures or strategies

sufficient to achieve and maintain compliance with applicable emissions

limits. Further, for sources subject to title V requirements, the

elements of such plans must, at a minimum, be consistent with any

applicable title V permit requirements concerning compliance plans.

Compliance with MRR requirements is critical to the integrity and

success of EIP's. Thus, an EIP must include enforcement provisions that

establish a regulatory structure which clearly and effectively deters

inadequate or improper MRR, providing for both State/local and Federal

penalties. Further, the enforcement provisions must include methods for

determining required data when MRR violations result in missing,

inadequate, or erroneous monitoring and recordkeeping data. These

methods must ensure that sources have a sufficiently strong incentive

to properly perform monitoring and recordkeeping in the first place.

E. Use of Program Revenues

Today's rules incorporate statutory restrictions on the use of

revenues generated by statutory EIP's. These restrictions are mandated

by section 182(g)(4)(B) of the Act on the use of revenues generated by

statutory EIP's submitted pursuant to sections 182(g)(3), 182(g)(5),

187(d)(3), and 187(g) of the Act. Revenues may be generated by an EIP

from a wide variety of fees or charges, including emission or permit

fees, fees associated with approving and recording trades, application

fees associated with labelling or sources opting into an EIP, and fees

or charges associated with TCM's. Specifically, any such revenues may

be used by a State for providing incentives for achieving emissions

reductions, providing assistance (up to 75 percent of costs) for the

development of innovative technologies for the control of O3 air

pollution and for the development of lower-polluting solvents and

surface coatings, and funding (with up to 50 percent of the revenues)

administrative costs of State programs under the Act. These

restrictions on the use of revenues do not apply to discretionary

EIP's.

Because the use of revenues from discretionary programs is not

constrained, some or all of the revenues generated by discretionary

EIP's may be rebated in order to create a revenue-neutral program, or

one with less revenue retained by the State. Rebate provisions of

revenue-generating EIP's can be designed to reduce the total cost to

the affected sources without diminishing the incentive to reduce

emissions created by the EIP. For example, an emission fee program

could place a fee on total emissions from affected sources, and rebate

an amount based on average emissions or percentage emissions reductions

of the affected sources. In a program with a large number of sources,

each source would only have a minor influence on the average emissions.

Thus, the rebate is not dependent on a source's own actions, and would

not distort the incentive of the fee on every unit of emissions created

by the source.

IV. Discussion of Comments and Regulatory Changes

This portion of the preamble is organized according to the

``Discussion of Issues'' section in the proposal, with additional

discussion of general issues raised in public comments. The following

discussion highlights the changes and clarifications made in the final

rules in response to the public comments on these issues.

A. Program Goals

1. Statutory Programs

Statutory EIP's are those programs submitted pursuant to sections

182(g)(3), 182(g)(5), 187(d)(3), and 187(g) of the Act, generally

because of failures in achieving required emissions reductions. The Act

does not specify the extent to which the EIP must, in and of itself,

make up for the specific failure in achieving the emissions reductions

necessary to meet the next milestone requirement. Rather, the

provisions specify only that the EIP ``shall be sufficient, in

combination with other elements'' of the plan, or together with a

``transportation control plan,'' to achieve the necessary reductions.

In the proposal, the EPA solicited comments on whether to require

that some specified minimum percentage of the required reductions be

met by a statutory EIP. Most commenters, including State and local

agencies, industry, and an environmental group, felt that EIP's should

not be required to meet a specified minimum percentage of emission

reductions. These comments were generally based on the premise that

opportunities for such reductions will vary because of potential

differences between nonattainment areas that may implement EIP's. A

specified minimum percentage would not provide recognition of these

differences nor the flexibility that needs to be an inherent part of

EIP's. On the other hand, an environmental group commented that a

specified minimum percentage of required reductions should be met by a

statutory EIP, equivalent to the percentage difference between what the

SIP is achieving and what the next milestone requires.

The final rules retain the requirement that a statutory EIP make a

significant contribution to the required emissions reductions, without

mandating any percentage reduction requirement or that the EIP assume

the entire burden of making up for the shortfall. This position is most

consistent with statutory intent that the States have flexibility in

determining how best to combine an EIP with other emission reduction

programs to achieve the necessary emissions reductions. Further, this

position is consistent with meeting the benefits sharing goal

established for all EIP's.

2. Discretionary Programs

In explicitly allowing for discretionary (i.e., nonstatutory) EIP's

to be included as SIP provisions, the Act does not impose any specific

emissions reductions requirements on such programs (sections

110(a)(2)(A) and 172(c)(6)). Thus, the proposed rules imposed no

specific emissions reductions requirements on discretionary EIP's. The

proposal relied upon the new State planning, quantitative progress, and

attainment requirements in the Act to ensure expeditious attainment of

the NAAQS, regardless of the type of emissions reductions programs that

States may choose to include in their SIP's.

Comments were received from an environmental group in support of an

alternative view outlined in the proposal. The alternative view is that

any savings in compliance costs resulting from discretionary EIP's

(relative to nonincentive-based programs) should be shared between two

accounts: the regulated sources should retain only as much savings as

is sufficient to maintain the incentive to participate in the EIP, with

the remainder of the savings being used by the State to reach

attainment more quickly than would be practicable under a nonincentive-

based plan. This alternative view is based on the statutory requirement

that States should attain the NAAQS as expeditiously as practicable.

In contrast, other commenters from State and local agencies,

industry, and a joint environmental/industry work group agreed with the

proposal that the EPA should not require discretionary EIP's to achieve

more rapid progress than other regulations. A joint environmental/

industry work group emphasized that EIP's should be designed to

increase flexibility and cost effectiveness, and should not be held to

any stricter standard than traditional programs. Several industry

commenters felt that requiring more rapid progress towards attainment

in exchange for a more flexible program appears to be a penalty

provision. These commenters felt that, while EIP's should be structured

to produce reductions equivalent to traditional SIP rules that the

EIP's replace, the addition of further reductions as the price for

entry into an EIP will discourage participation and reduce benefits

that might otherwise result from broad participation. A State agency

disagreed with requiring greater emission reductions from discretionary

EIP's since different types of environmental benefits can be achieved

by EIP's, such as technological innovation, more available capital for

other control measures, conservation of natural resources, and

increased commitment from the regulated sources. Another State agency

believes that EIP's which replace traditional SIP requirements should

be equally effective, equitable, and enforceable as the program it

replaces.

The final rules take into account the broad array of benefits that

can result from the use of discretionary EIP's, the statutory

requirement for expeditious attainment, and the fact that EIP's are

relatively new and controversial in principle as well as in practice.

Further, current experience with EIP's makes clear that successful

adoption and implementation of EIP's requires some degree of consensus

among the interested groups that both the regulated entities and the

environment will benefit from such programs. Thus, the final rules and

guidance establish as a goal for all EIP's that they be designed to

benefit both the environment and the regulated entities. In so doing,

the final rules and guidance require States to meet this benefits

sharing goal, while providing flexibility to the States to determine

how best to do so. As a result, EIP's will increase flexibility, lower

the cost of attaining and maintaining the NAAQS, and provide stronger

incentives for the development and implementation of pollution

prevention measures and innovative technologies.

Benefits from discretionary EIP's can be defined in various terms,

as discussed in paragraph III.D.1. While the EPA encourages that

discretionary EIP's be designed to produce environmental benefits

directly, through increased or more rapid emissions reductions, States

should consider these and other benefits in designing a program to meet

the goal of sharing benefits between the regulated entities and the

environment. In many cases, benefits in terms of cost savings will not

be quantifiable prior to program implementation, due to the complex

market decisions that sources participating in an EIP will need to make

and changes in market conditions during the course of the program.

Thus, the final rules and guidance include analysis of control cost

savings, to the extent practicable, as a part of the required program

audit.

However, the difficulty of quantifying cost savings and the extent

to which those cost savings constitute an incentive to trade leads the

EPA to conclude that it is not practicable to require that all EIP's

discount trades or otherwise require increased or more rapid emissions

reductions that directly benefit the environment. The authorization for

discretionary EIP's in sections 110(a)(2)(A) and 172(c)(6) may be

interpreted to indicate Congress' view that such programs may help

achieve emissions reductions more effectively or efficiently, but not

necessarily more expeditiously, than traditional regulatory

requirements.

The final rules reflect that it most appropriately falls to the

States to determine the type and extent of benefits sharing that is

practicable and appropriate, given the unique circumstances that any

particular discretionary EIP is designed to address. Therefore, the

final rules do not require any specific formula for benefit sharing.

However, the final rules do recognize that the issue of benefits

sharing will be part of the political consensus building process

associated with designing a discretionary EIP. In assessing this issue,

States should not confuse this sharing with accounting for uncertainty

in an EIP. Since uncertainty is to be accounted for through compliance

and programmatic uncertainty factors (see paragraph III.F.),

determining a degree of sharing based on weighing the uncertainty in an

EIP would in essence be accounting twice for the same uncertainty.

One commenter also argued that the requirements for attainment as

expeditiously as practicable [section 181(a)(1)] and for imposition of

reasonably available control measures [section 172(c)(1)] mandate the

inclusion of emission fees in EIP's. The EPA encourages States to

consider emissions fees, but does not believe that, at present, their

impacts are sufficiently well understood in all cases to conclude that,

for all EIP's, they are either practicable or reasonably available.

B. Interface With Reasonably Available Control Technology (RACT) and

Other Statutory Requirements

1. RACT

The proposal was based on an interpretation of the statutory RACT

requirements that authorizes sources subject to the statutory RACT

requirements (RACT sources) to meet their RACT obligations in the

aggregate (i.e., through trading among themselves), and, when such

trading results in an exceptional environmental benefit, by acquiring

emissions reductions from non-RACT sources (as discussed in paragraph

II.D.2.). Further, the proposal defined exceptional environmental

benefits in terms of the statutory offset ratios for nonattainment

areas and other demonstrations of exceptional long-term environmental

benefits.

With regard to meeting RACT in the aggregate, all but one commenter

agreed with the proposed position that trading be allowed among all

RACT sources. Further, these commenters generally felt that such RACT

trading should produce emissions reductions that are equivalent to

those that would be obtained if each source met its source category-

specific RACT limit. On the other hand, one environmental group

disagreed with the proposed position allowing all sources covered by

RACT requirements to trade among themselves. This commenter stated that

nothing in the Act specifically authorizes substituting any trading

regime for source-specific RACT requirements. However, if the EPA

allows trading to meet RACT requirements, only trading within a given

RACT source category should be allowed since section 182(b)(2)

addresses RACT by source categories. Further, this commenter stated

that since RACT limits have historically been set based on source-

specific economic and technical constraints, ``tradeable'' RACT limits

must be based on an analysis of the cost savings achievable by meeting

RACT through whatever trading approach is permitted in the RACT rule.

Since trading approaches provide increased compliance flexibility and

cost savings, the commenter believes that any ``tradeable'' RACT limits

should be lower than source-specific RACT limits.

With regard to RACT/non-RACT trading in general, most commenters,

including industry, State and local agencies, and an environmental

group, supported such trading. Some stated that any regulation which

requires certain reductions to be obtained at specified sources, and

nowhere else, contradicts a ``market-based'' approach. They felt that

the broadest possible participation in a trading market should be

encouraged so as to achieve the most benefits from the program. Some

commenters felt that allowing RACT/non-RACT trading encourages the

development of new technologies and facilitates obtaining controls on

previously unregulated sources and source categories. Limiting trades

to particular source categories was thought by some to substantially

reduce both the incentives and savings available. Such comments were

premised on the belief that trading between different source categories

(involving both RACT and non-RACT categories) can have sufficient

controls and safeguards built in to ensure compliance.

On the other hand, other environmental groups opposed RACT/non-RACT

trading. One such commenter asserted that statutory language regarding

RACT ``sources'' only refers to stationary sources, such that trading

between RACT sources and mobile sources would violate the Act. Further,

this commenter asserted that such trading would make it impossible for

States to manage mobile source and stationary source budgets properly

for purposes of demonstrating RFP and attainment. The other

environmental group commended the EPA's objectives, and approved its

means in theory, of allowing trades between mobile and stationary

sources, but concluded that the time for trading between stationary and

mobile sources has not arrived. This conclusion was premised in part on

the belief that trading between RACT sources and mobile sources

violates the Act, because it is impossible to determine whether a given

mobile source emission reduction is truly surplus. Further, both

commenters felt that mobile source emissions reductions could not be

reliably quantified.

As to the conditions under which RACT/non-RACT trading may occur,

many commenters from industry expressed the view that such trading

should be allowed at a 1-to-1 ratio, i.e., that no exceptional

environmental benefit was required to justify RACT/non-RACT trading.

These commenters felt that any trading ratio greater than 1 to 1 would

limit the economic, technological, and environmental benefits that

could be derived from innovations brought about by RACT/non-RACT

trading. Other commenters, including State and local agencies and some

industries and environmental groups, supported the concept of requiring

RACT/non-RACT trades to achieve an exceptional environmental benefit in

general, and the use of the proposed statutory offset ratios in

particular. However, some of these commenters expressed concern that

the offset ratios may have a chilling effect on such trading, and

encouraged the EPA to identify justifiable circumstances under which

trading ratios could be lower than the offset ratios.

The final rules continue to allow RACT to be met in the aggregate.

In addition, the final rules continue to allow RACT/non-RACT trading,

provided that an exceptional environmental benefit is achieved.

Under the 1977 Act, the requirements specific to nonattainment

SIP's were found in part D of title I of the Act. Section 172 specified

the attainment date and the required SIP measures. Subsection (a) of

section 172 required that nonattainment SIP's provide for attainment by

specified dates; subsection (b)(2) required that those SIP's ``provide

for the implementation of all reasonably available control measures

(RACM) as expeditiously as practicable.'' Subsection (b)(3) required

that the SIP's provide for RFP, including RACT:

(Nonattainment SIP's must) require, in the interim (prior to the

attainment date) reasonable further progress * * * including such

reduction in emissions from existing sources as may be obtained

through the adoption, at a minimum, of reasonably available control

technology.

The EPA took the position that RACT requirements do not require

each affected emissions unit to achieve a prescribed amount of

reductions in emissions from its own processes, but rather require the

affected sources to achieve in the aggregate the reductions that would

be achieved if each applied RACT controls to itself. Under the EPA's

interpretation, the application of the requirement to impose RACT upon

``existing sources'' meant that RACT applied in the aggregate, as

opposed to source by source. This interpretation, which is reflected in

the Emissions Trading Policy Statement (51 FR 43814 (December 4, 1986),

the ``Bubble Policy''), was upheld in NRDC v. EPA, 33 ERC 1657 (4th

Cir. 1991), an unpublished decision. There, the Court of Appeals for

the Fourth Circuit upheld as reasonable EPA's approval of a Maryland

SIP revision for the American Cyanamid Company relaxing the SIP limit

on several lines in exchange for tighter limits on other lines. The EPA

reasoned that the RACT requirement was met by the subject lines in the

aggregate.

The Act revamped part D of title I by updating the general

requirements applicable to all nonattainment SIP's, placing those

requirements in subpart 1 of part D, and adding subparts 2-5 to cover

pollutant-specific nonattainment SIP's. Subpart 2 concerns ozone SIP's.

Under the 1990 Amendments, the 1977 Act's requirements for

nonattainment SIP's were generally retained in subpart 1, but were

combined differently--the RACM and attainment date requirements were

consolidated into one provision and the RACT requirement was shifted to

the RACM provision. Those provisions (section 172(c)(1)-(2)) now read:

(1) In General--Such (nonattainment SIP) provisions shall

provide for the implementation of all reasonably available control

measures as expeditiously as practicable (including such reductions

in emissions from existing sources in the area as may be obtained

through the adoption, at a minimum, of reasonably available control

technology) and shall provide for attainment of the national primary

ambient air quality standards.

(2) RFP--Such plan provisions shall require reasonable further

progress.

In addition, subpart 2 contains several RACT provisions. Most

importantly, section 182(b)(2) sets out the RACT requirement for areas

classified moderate or higher, as follows:

The State shall submit a revision to the applicable

implementation plan to include provisions to require the

implementation of reasonably available control technology under

section 172(c)(1) with respect to each of the following:

(A) Each category of VOC sources in the area covered by a CTG

document issued by the Administrator between the date of enactment

of the Clean Air Act Amendments of 1990 and the date of attainment.

(B) All VOC sources in the area covered by any CTG issued before

the date of the enactment of the Clean Air Act Amendments of 1990.

(C) All other major stationary sources of VOC's that are located

in the area.

Each revision described in subparagraph (A) shall be submitted

within the period set forth by the Administrator in issuing the

relevant CTG document. The revisions with respect to sources

described in subparagraphs (B) and (C) shall be submitted by 2 years

after the date of the enactment of the Act, and shall provide for

the implementation of the required measures as expeditiously as

practicable but no later than May 31, 1995.

Under the 1990 Act, the EPA continues to take the position

established under the 1977 Act that RACT applies in the aggregate

because the RACT requirement of section 172(c)(1) of the Act is phrased

identically to the RACT requirement of the 1977 Act (vis., ``existing

sources''). EPA does not read section 182(b)(2) to indicate to the

contrary. Rather, the cross-reference to section 172(c)(1) contained in

section 182(b)(2) indicates that RACT is to be interpreted in the same

manner under section 182(b)(2) as under section 172(c)(1).

In addition, the EPA interprets the RACT requirement to authorize

emissions trading among the stationary sources subject to the RACT

requirement (``RACT sources'') and those not subject (``non-RACT

sources'') when emissions reductions result in an amount that provides

an exceptional environmental benefit, e.g., a level of reductions that

is significantly greater than RACT-level amounts. This interpretation

entails viewing the RACT requirement as generally requiring a specified

level of reduction of emissions from stationary sources subject to

RACT, but as authorizing those sources to substitute significantly

greater emissions reductions credits from non-RACT sources in lieu of

putting controls on themselves.

The EPA acknowledges that the statute permits different

interpretations, including the interpretation that the universe of

sources subject to RACT must themselves implement RACT-level controls,

and therefore may not trade with non-RACT sources. However, the EPA

believes that its interpretation allowing such trading is permissible,

based on the language of section 172(c)(1). The EPA's interpretation

emphasizes that the RACT requirement is an emissions reduction

requirement for stationary sources that is designed to yield reductions

to facilitate the ultimate attainment of the NAAQS and, in the interim,

RFP towards attainment (sections 172(c)(1)-(2)).

Section 172(c)(1), as quoted above, requires SIP provisions to

provide ``such reductions in emissions from existing sources in the

area as may be obtained through the adoption, at a minimum, of

reasonably available control technology. This provision requires an

amount of emissions reductions that equates to the amount that would

result from the imposition of ``RACT'', but does not require the

imposition of any particular set of controls or technologies. Further,

the term ``RACT'' is not defined in the statute. In light of the

function of this term--to identify the level of required emissions

reductions--the EPA believes the term may be defined either as a

specified level of emissions to be reduced from the RACT source itself,

or as little as a zero level of reductions from the RACT source,

coupled with the acquisition by the RACT source of emissions reductions

from sources other than RACT sources in an amount that will yield an

exceptional environmental benefit.

With respect to the level of emissions reductions required from the

RACT source itself, the EPA believes that if the RACT source acquires

an appropriate amount of emissions reductions ``credits'' from non-RACT

sources, it is not reasonable to require additional reductions from the

source itself. Under these circumstances, control technology needed to

produce such reductions from the source itself is not ``reasonably

available''.

With respect to the level of emissions reductions required from the

non-RACT sources, the final rules retain the proposed approach to

define such a benefit in terms of the statutory offset ratios in

general, although flexibility is provided if exceptional environmental

benefits are otherwise demonstrated, with a lower bound for the trading

ratio of 1.1 to 1 in such cases. EPA believes that these additional

amounts of reductions are required because it is ``reasonable''--within

the meaning of the amount of reductions required through ``RACT''--to

forego reductions that could be obtained at the RACT source itself only

when the trading program will result in an exceptionally strong benefit

to the environment. In addition, requiring substantial additional

emissions reductions credits from non-RACT sources is consistent with

the underlying purpose of the RACT requirement--to assure reductions

that result in an important step towards fulfilling the RFP and

attainment requirements.

The EPA incorporated statutory offset ratios because offsets are an

aspect of emissions trading, and thus provide an indication of

Congress' view of benefits to the environment to be required in this

context of emissions trading.

Section 182(b)(2), quoted above, does not alter EPA's analysis.

Section 182(b)(2) mandates ``the implementation of reasonably available

control technology under section 172(c)(1) with respect to (three

categories of stationary sources).'' The EPA interprets the cross-

reference to section 172(c)(1) to incorporate into section 182(b)(2)

the definition of the phrase ``reasonably available control

technology'' and the RACT requirement generally under section

172(c)(1). In addition, the EPA interprets the phrase ``with respect

to'' to authorize RACT sources to acquire emissions reductions credits

in the manner described above, and not to mandate the imposition of

controls directly on the RACT sources. The EPA believes that this

provision may be interpreted to identify the source categories

responsible for securing RACT-level reductions, and to mandate the

time-frame for them to do so; but does not mandate that those sources

themselves implement the emissions reductions measures.

The EPA believes that its interpretation is permissible under

Chevron U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S. 837

(1984), because the relevant statutory provisions are not defined in

the statute in a manner that makes clear whether sources subject to

RACT may acquire the necessary emissions reductions from other sources

in lieu of imposing the controls themselves. As a result, the EPA may

proceed to interpret the provision in a manner that is reasonable and

consistent with the purpose of the statute. (See generally sections

110(a)(2)(A) and 172(c)(6) (authorizing SIP measures to include

``economic incentives such as * * * marketable permits'').)

As discussed above in paragraph IV.A.2., the final rules and

guidance require that EIP's be designed to meet the goal of sharing

benefits between the environment and the regulated entities. For EIP's

that allow trading or other types of compliance flexibility to meet

RACT requirements, as with any EIP, the EPA encourages States, to the

extent practicable, to meet this benefits sharing goal most directly by

requiring increased emissions reductions beyond those that would be

achieved through a traditional RACT program. Increased reductions could

be created in a number of ways, such as by including more sources in

the program or requiring a greater than 1-to-1 trading ratio. Depending

on the scope and nature of an EIP, compliance flexibility might include

not only emissions trading between sources, but also alternative

compliance methods such as pollution prevention, energy conservation,

and fuel switching.

RACT/non-RACT trading programs must, of course, also meet the other

requirements in the final rules, such as those that relate to credible,

workable, and replicable quantification methods and to monitoring,

recordkeeping, and reporting that allow for compliance determinations

and State and Federal enforceability. The EPA recognizes that several

commenters raised concerns about the technical workability of emissions

trades involving mobile sources. Congress arguably contemplated that

EIP's could incorporate trades involving mobile sources, as indicated

by the definition of an EIP in section 182(g)(4)(A) to include

``incentives and requirements to reduce vehicle emissions and vehicle

miles traveled in the area, including any of the transportation control

measures identified in section 108(f).'' The EPA will address technical

concerns raised by commenters when it finalizes guidance on the

generation of ERC's from mobile source control programs.

Beyond the requirements in the final rules, the EPA is developing

more specific guidance on the use of emissions trading to implement new

NOX RACT requirements. This guidance will address issues such as

setting tradeable NOX RACT limits and baselines, and is consistent

with the general RACT trading principles set out in paragraphs III.D.2.

and III.D.3. The EPA intends to work with States who want to develop

trading-based RACT programs to incorporate the requirements of the EIP

rules and related guidance into EIP's that are environmentally sound

and administratively efficient.

2. Offsets

The EPA received a number of comments specifically dealing with NSR

offset issues. These covered a range of issues, but focused primarily

on offsets banking. Such issues are beyond the scope of this EIP

rulemaking, but the EPA intends to address them in the near future in

guidance on ERC banking currently being developed. In the interim, the

EPA intends to work with States who want to develop offset banking

programs.

3. ECO Programs

The EPA received a number of comments dealing with ECO programs

which are beyond the scope of this EIP rulemaking. The EPA has

previously issued guidance on ECO programs and anticipates the

development of additional guidance. Final action with respect to ECO

programs will occur when the EPA acts on SIP revisions concerning ECO

programs.

C. Program Baseline

The proposed rules were based on the premise that a State can only

take credit in attainment and RFP demonstrations for emissions

reductions from EIP's that are surplus to what is otherwise required

and credited to other elements of a federally-approved SIP. This

restriction is necessary to ensure that a State does not double count

emissions reductions in SIP demonstrations. The general requirements

for program baselines are intended to ensure that such double counting

does not occur, while still providing as much flexibility as possible.

The proposal solicited comments on the conditions under which

States should have the flexibility to use an ``allowable'' baseline. In

particular, comments were solicited on the proposed approach to accept

an ``allowable'' baseline in an EIP submitted in conjunction with the

submission of an applicable progress plan (e.g., 15 percent RFP plan

and/or subsequent 3 percent-per-year plans), prior to the submission of

an attainment demonstration. Further, comments were solicited on

approaches for achieving consistency between EIP's with ``allowable''

program baselines and statutory RACT, RFP, and attainment requirements.

There were many comments from industry and State and local agencies

in support of the proposed flexibility in setting baselines. These

comments generally supported the concept of considering the use of

allowable emissions in setting EIP baselines, provided the EIP is

consistent with RFP and attainment demonstrations. The commenters did

not, however, address how such consistency could be achieved or

demonstrated. Some State agencies commented that if allowable emissions

baselines are used, they should not lead to more actual emissions, in

the aggregate area-wide, than allowed under a traditional plan. The

commenters felt that this flexibility would allow States to select

baselines that were the most practicable and equitable to all sources

involved.

An alternative view was expressed by an environmental group which

advocated that the final rules should require an actual emissions

baseline for all EIP's until the attainment demonstration is approved.

This comment was premised on the belief that an allowable emissions

baseline would violate the requirements for attainment as expeditiously

as possible and for noninterference with attainment. The commenter

asserted that relying only on a RFP demonstration and a commitment by

the State that a future attainment demonstration would be consistent

with the EIP baseline was a wholly inadequate constraint to ensure

expeditious as practicable attainment. Further, this commenter

expressed the view that ``surplus'' reductions should be defined

relative to those reductions which are necessary to achieve attainment.

As a result, the commenter concluded that the EPA should not approve

any EIP's based on emissions trading prior to approval of an attainment

demonstration.

The final rules and guidance focus on consistency between progress

plans and EIP baselines. The rules recognize that RFP requirements are

defined in terms of actual areawide emissions reductions and annual

progress. Although such consistency and requirements may be made more

difficult by the use of an EIP baseline which incorporates allowable

emissions, the final rules provide States flexibility in designing an

EIP to achieve these requirements. Further, the final rules encourage

the development of EIP's as part of an overall attainment strategy that

lowers the cost of attainment. The final rules recognize that

attainment strategies that incorporate EIP's can reflect both

environmentally and economically sound policy choices. Therefore, the

final rules retain the proposed baseline flexibility and definition of

surplus, while requiring States to demonstrate in their EIP submittal

that the EIP baseline is consistent with their progress plans15

and RACT requirements, when applicable, and to commit that such

consistency will be reflected in any subsequent progress plans and

attainment demonstrations. The State should describe how the EIP

baseline will be integrated into a subsequent attainment demonstration.

The EPA takes the position that an allowables baseline, when consistent

with a submitted, complete, and potentially approvable RFP plan

generally is permissible. It is true, as one commenter emphasized, that

consistency with RFP does not automatically assure consistency with

attainment when additional reductions are needed for attainment.

However, the EPA takes the position that an allowables baseline that is

consistent with an RFP submittal does not specifically interfere with

attainment under section 110(l). The State's commitment that the

attainment demonstration, when submitted, will be consistent with the

allowables baseline lends additional support to the EPA's position. The

inducement to States to complete the attainment demonstration that is

presented by the sanctions/FIP requirement, as well as the fact that

emissions limits allowed under the EIP may be tightened if they

unexpectedly develop into impediments to attainment, further support

the EPA's positions.

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\1\5EPA has concluded that it is not necessary in this notice to

define RFP with any greater specificity than found in the statute;

that is, it is not necessary to identify the extent, if any, of

annual emissions reductions needed to comply with the statutory RFP

requirements.

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As stated above in paragraph IV.B.1., the EPA is developing

guidance that addresses baselines for EIP's implementing new NOX

RACT requirements. Further, the EPA intends to work with States who

want to develop trading-based RACT programs to incorporate the

requirements of the EIP rules and related guidance into EIP's that are

environmentally sound and administratively efficient.

D. Emission Quantification

1. Criteria for Adequacy of Approach

The proposed rules and guidance were based on the premise that the

development and use of credible, workable, and replicable methods to

quantify emissions are necessary elements of any quantifiable EIP. The

proposed rules require EIP quantification methods to have a level of

certainty comparable to that for source-specific standards and

traditional methods of control strategy development. The proposal

explicitly allowed States to develop alternative approaches to meet

these emissions quantification requirements. The proposal solicited

comments on adequacy criteria for various types of source categories,

recognizing that no one approach is the most appropriate, or even

technically feasible, for all source categories.

Most comments received on this issue were supportive of the general

requirements in the proposal. Of those supporting the general

requirements, no commenters offered any specific criteria for levels of

certainty or accuracy by which quantification approaches should be

evaluated. On the other hand, an environmental group commented that,

for trading programs, the EPA should require the use of the most

accurate available continuous emissions monitors (CEM's) on every

source in an emissions trading program, and, where such direct

emissions quantification is not possible, no emissions trading should

be allowed.

The final rules reflect the importance of both ensuring

environmental protection with an adequate degree of accountability and

fostering the development of innovative and flexible programs.

Innovation and flexibility would be unduly restricted if the use of the

most accurate available CEM's were a prerequisite for all sources to be

included in any emissions trading program. The final rules recognize

that other approaches may be more appropriate for various source

categories. The final rules reflect that credible approaches

necessarily entail levels of accuracy and precision sufficient to

determine compliance and allow for effective enforcement of all

emission limits in any EIP. Subject to these enforceability

considerations, the final rules address uncertainty in emission

quantification in determining SIP credit through the use of a

programmatic uncertainty factor.

A commenter stressed that the need to assure accuracy in trading

would further burden State agencies, and argued that EPA could not

approve an EIP absent a demonstration that the State agency has

adequate resources to handle the additional workload. Many of the

additional requirements Congress imposed on States through the Clean

Air Act Amendments of 1990 would place additional burdens on State

agencies--EPA intends to implement the Act's requirements that States

have sufficient resources (e.g., section 110(a)(2)(E)) in the context

of EIP submissions in the same manner as EPA implements these

requirements in the context of other SIP submissions.

2. Extended Averaging Times

The proposed rules recognize that long-term averaging by individual

sources can significantly relax standards that require compliance on a

short-term basis and jeopardize RFP and attainment demonstrations that

are based on ``typical summer day'' emissions. The proposal also

recognized that EIP's which require a number of sources to comply with

total emissions caps or average emission rate limits could potentially

mitigate this type of rule relaxation. In such programs, random daily

positive fluctuations in emissions that are likely to occur from any

given source (i.e., emission ``spikes'' that could jeopardize

attainment) may tend to be compensated for by random daily negative

fluctuations from other sources. Thus, the proposal allowed long-term

averaging, provided a statistical showing is made that the long-term

caps or limits are consistent with applicable demonstrations of RFP on

the basis of typical summer day emissions, demonstrations of attainment

of short-term NAAQS, and RACT requirements. The proposed approach

provided increased flexibility to sources and to States in their plan

development without undermining the EPA's traditional control programs

or the validity of RFP or attainment demonstrations.

The proposal recognized the need for additional guidance on such

statistical ``equivalency'' showings. The proposal also solicited

comments on specific approaches for RACT equivalency showings,

including the use of a presumptive norm discount factor of 70 percent

to be applied to a RACT limit averaged over 30 days, other rule-

specific discount factors determined by States to represent RACT

equivalency, and the use of short-term caps in conjunction with long-

term caps or limits.

Many commenters supported the proposed flexibility to allow for

long-term averaging. One State commenter strongly supported the

provision to allow States to relate long-term averaging to daily

emissions by statistical analysis. Another State agreed that the use of

long-term averaging should not come at the expense of attaining short-

term standards or demonstrations of compliance. Other States noted the

need for consistency in the EPA's RACT guidance on averaging times.

Industry commenters endorsed the allowance of long-term averaging,

although they expressed differing views about the need for statistical

showings to demonstrate consistency with RACT and short-term standards.

Some felt that any such showing should not be burdensome, while others

disagreed that any such showing was necessary. An environmental group

agreed that increasing averaging periods can significantly relax

standards and threaten RFP and attainment. This group commented,

however, that the proposal understated the difficulties which would

flow from such a relaxation, and felt that discount factors would not

provide adequate protection against spikes in emissions which could

prevent attainment of short-term NAAQS.

With regard to long-term averaging and RACT equivalency, many

commenters disagreed with the use of a presumptive 30-day RACT

equivalency factor, such as the 70 percent factor mentioned in the

proposal. One commenter felt that a RACT equivalency showing should not

be required if some statistical information was provided showing that

long-term averaging would not interfere with RFP or the attainment

demonstration. Many regulatory agency and industry commenters supported

allowing States flexibility in determining RACT equivalency factors.

The final rules retain the proposed allowance for long-term

emissions averaging, as well as requirements that States make

statistical showings that any such emissions averaging is consistent

with applicable RACT, RFP, and short-term NAAQS. These statistical

showings are necessary to show equivalency to, or noninterference with,

each of these statutory requirements, although as a practical matter

the same showing may suffice to assure consistency with more than one

of the requirements. The statistical showings should take into account

the extent to which emissions variations from an individual source or

from all sources are random or systematic and, thus, the extent to

which the variations can be considered to be independent. The showings

must demonstrate that the pattern of emissions resulting from relaxed

averaging periods would approximate the pattern of emissions that would

occur without relaxed averaging periods to an extent sufficient to

reasonably conclude that the relaxed averaging periods would not

interfere with the statutory requirements.

The final rules do not include any presumptive RACT discount

factor, on the basis that no one factor can adequately account for the

variations that may occur across different programs. However, the EPA

remains open-minded to discount factors, especially for specific

industries, that are substantiated by State analyses. The EPA will work

with States that want to develop EIP's that incorporate long-term

averaging requirements to ensure that such a program does not interfere

with RFP and the attainment of short-term standards. The EPA

anticipates that more general guidance will be developed in the course

of working with States on statistical approaches for such equivalency

demonstrations. In the case of EIP's implementing RACT requirements,

the guidance referenced above in paragraph IV.B.1. addresses long-term

averaging for NOX RACT.

E. Monitoring, Recordkeeping, Reporting (MRR)

The proposed rules were based on the premise that EIP's depend more

strongly than traditional control programs on MRR to ensure compliance

and to allow for adequate enforcement because they are inherently more

flexible and less prescriptive than traditional technology or

performance standards. The proposal recognized that while a wide range

of MRR approaches are available that can be used to show compliance for

different types of sources, no one approach is necessarily the most

appropriate, or even technically feasible, for all types of sources

that may be included in an EIP. Thus, the proposal explicitly allowed

for alternative monitoring methods, while soliciting comments on

criteria for adequate MRR requirements for EIP's.

Public comments focused on whether EIP's do depend more strongly on

MRR and on whether CEM's should be required for any or all sources

covered by an EIP. Several industry commenters disagreed with the

premise that EIP's depend more strongly on MRR to ensure compliance,

and, therefore, felt that no more stringent MRR requirements should be

required in EIP's than those required in traditional programs. These

commenters supported the provision allowing a range of MRR requirements

to be used in EIP's.

One State commented that EIP's should be limited to source

categories for which emission quantification and compliance methods are

available and reasonably accurate. This State felt that the use of

CEM's was the optimal monitoring method, although it recognized that

other unit-specific field monitoring methods could be acceptable. An

environmental group commented that the rules should require use of the

most accurate available CEM's on every source involved in any emissions

trading program. Further, this group felt that the maximum amount of

CEM measurement inaccuracy should be reflected in a program discount

factor. On the other hand, some industry commenters urged that EIP's

not require the use of CEM's for any sources.

The final rules retain the proposed flexibility for alternative

monitoring approaches that allow for adequate compliance determinations

and provide for effective State and Federal enforcement. As discussed

above (see paragraph IV.D.1.), innovation and flexibility would be

unduly restricted if CEM's were a prerequisite for all sources in any

emissions trading program. In the development of adequate MRR

requirements, criteria should be considered to assure that quality-

assured, representative monitoring data will be obtained that can be

used to determine compliance.

The EPA recognizes that special consideration should be given to

developing MRR requirements for small sources to avoid undue burdens,

consistent with assuring that all EIP sources are required to comply

with adequate and effective MRR requirements. For mobile source

programs, the State should refer to program-specific guidance from EPA,

if applicable.

F. State Implementation Plan (SIP) Creditability

The proposed rules identify various types of uncertainties

associated with different categories of EIP's, and required that States

apply discount factors in calculating SIP credit based on the

uncertainties inherent in the design of any given EIP. The proposal

separately addressed compliance-related uncertainty, through a rule

compliance factor, and programmatic uncertainties associated with

quantification methods and projected market responses, through a

program uncertainty factor. The proposal compared the need for a rule

compliance factor to the historical use of a rule effectiveness factor,

generally set at 80 percent for traditional stationary source SIP

programs. The proposal identified an option of setting presumptive

norms for these factors in lieu of the requirement that the State

develop and justify program-specific factors. The proposal solicited

comments on criteria for the development of such factors.

Many commenters expressed different concerns with the proposed

approach to dealing with uncertainty. Some commenters interpreted the

proposal as allowing credit only for emission-limiting programs (e.g.,

emission trading), and argued that credit should be allowed for market-

response programs (e.g., emission fees) and even directionally-sound

programs (e.g., those that benefit the environment but cannot be

quantified). One such commenter, an environmental group, urged not only

that credit be given for emission fee programs, but that they must be

encouraged since they offer the most attractive opportunity for

environmental progress. In fact, the proposed and final rules allow

credit for market-response as well as emission limiting programs, and

encourage States to consider all such types of programs. The proposed

and final rules also encourage the use of directionally-sound programs,

but specify that SIP credit cannot be taken until sufficient experience

with the program results in the ability to adequately quantify the

results.

Some State commenters expressed general concern with the use of any

up-front discounting of SIP credit, urging instead that alternative

approaches be allowed to account for uncertainty. In particular, some

State commenters recommended that the program audit procedures be used

to provide information on actual emissions reductions resulting from

program implementation. Such audit results would feed back into updated

emissions inventories, be compared to initially projected program

results, and if appropriate, result in additional credit or the need

for additional reductions if the audited results differ from those

credited to the EIP in the SIP. One State commenter recommended that

the State be allowed to adopt various back-up provisions in an EIP

instead of applying up-front discount factors.

Some industry commenters disagreed with the use of two discount

factors, on the basis that such an approach would double count

uncertainty. These commenters also expressed the view that a

presumptive norm of 80 percent for a rule compliance factor is too low.

On the other hand, an environmental group commented that a presumptive

norm of 80 percent was too high. This commenter also urged that credit

not be given for prior reductions or for plant shutdowns and slowdowns

which would have occurred in the absence of a control program.

The final rules generally retain the proposed approach of requiring

the State to develop and apply discount factors to account for

compliance-related and programmatic design uncertainties. In addition,

however, the final rules also include further guidance and criteria for

developing and justifying such factors. In particular, various aspects

of program design should be considered in developing such factors,

including but not limited to the type of incentive mechanism upon which

the program is based; the variability in emissions from affected

sources and the nature and extent of uncertainty in the emissions

quantification procedures required by the program; the type and

frequency of MRR required by the program; sanctions for noncompliance;

the frequency, scope, and committed responses to program audits; and

the nature of administrative procedures to be used by the State in

implementing and enforcing the program.

G. Audit/Reconciliation Procedures

The proposed rules specify that program audits be made at least

every 3 years, consistent with intervals associated with RFP milestones

and emission inventory requirements. Alternatively, the State could

specify a shorter period, so as to allow time to make programmatic

corrections or adjustments (in either direction) to SIP credited

emissions reductions, before an RFP milestone is reached. The proposal

solicited comments on the appropriate audit frequency.

Several comments were received on the general issue of programs

audits. Most such comments were generally supportive of a requirement

for ongoing program tracking and feedback, although the commenters

differed on the role that the audit should have relative to other EIP

requirements. Some State commenters felt that ongoing audits should

serve as an alternative to many of the proposed regulatory requirements

for up-front technical analyses. Another State supported the use of

audits to assess EIP adequacy and the need to take corrective actions.

An environmental group recommended that the EPA require for all EIP's

contingency measures to compensate for shortfalls revealed through the

audits. Other State, environmental, and industry commenters felt that

requiring audits was reasonable, but expressed varying degrees of

concern that audits not become so burdensome as to serve as a

disincentive for developing an EIP. On the other hand, one industry

commenter felt that EIP's ought not be subject to any special audit

requirements different from those applicable to traditional programs.

On the issue of audit frequency, most commenters generally agreed

with the proposed 3-year interval. One State commenter felt that annual

audits should be conducted to assess progress, with a summary of such

audits to be incorporated in triennial SIP RFP reports.

The final rules and guidance retain the proposed requirements for

program audit and reconciliation procedures, and establish 3 years as

the maximum time interval for conducting such audits. The final rules

recognize that the State has flexibility in establishing the frequency

(within the 3-year constraint) and scope of audit provisions. Further,

the final rules recognize that there is an interplay between the

frequency, scope, and other design features of the audit provisions and

the nature and scope of other program design elements (such as the

justification for uncertainty factors). In addition, to better define

the benefits from EIP's, the final rules include analysis of control

cost savings, to the extent practicable, as a part of the required

program audit.

H. Penalties for Noncompliance

The proposed rules recognize that determination of statutory

maximum penalties for noncompliance is significantly complicated in the

case of EIP's that incorporate multisource emissions caps and/or long-

term averaging times, since Federal statutory maximum penalty authority

is specified on a per-day, per-source basis. While establishing the

principle that such penalty provisions must create a deterrent effect

comparable to that of traditional programs, the proposal solicited

comment on criteria for the development of such penalty provisions.

Commenters generally agreed with the principle of equivalent

deterrence. Several industry commenters opposed any criteria that would

suggest that any multisource emissions cap violation should be

considered to have occurred at each source. Some commenters recommended

that penalty provisions be based on the amount of the exceedence of a

cap, and one commenter suggested that the final rules should recommend

predetermined minimum penalties. Another commenter recommended that

penalty provisions differentiate between violations that are willful or

negligent and those that are determined not to be willful or negligent.

The final rules and guidance continue to allow for a variety of

approaches to specifying statutory maximum penalties, although

exceedance-based approaches are encouraged. Thus, for example, where

emission limits are specified in units of mass emissions, statutory

maximum penalties can be specified as a function of the degree to which

the limits are exceeded, as measured in terms of some increment of mass

emissions. Alternatively, statutory maximum penalties could be

specified as a function of the cost of credits or allowances in trading

programs. The final rules and guidance require that EIP's be structured

in conjunction with applicable enforcement authorities, in such a way

that violations of multisource and/or multiday emission limits

translate into sufficient numbers of some combination of violations,

sources in violation, and days of violation. There are no criteria that

suggest that this requirement should necessarily be met by considering

that the violation occurred at each such source. The final rules

further identify supplemental provisions that may enhance deterrence,

such as mandatory minimum penalties, or address uncertainties inherent

in the design of a program, such as penalty triggers linked to measures

of compliance tracked through the program audit.

The following criteria have been established for assessing the

adequacy of the deterrent effect of EIP penalty provisions. The primary

focus is on an assessment of the adequacy of the statutory maximum

penalties in the EIP, through an evaluation of deterrence ratios (i.e.,

the ratio of the maximum penalty per violation to the cost of

compliance). In a program with tradeable emission allowances or ERC's,

the cost of compliance will be related to the market value of

allowances or credits. Under a range of foreseeable noncompliance

circumstances, this deterrence ratio must be high enough to deter

noncompliance to a degree comparable to traditional programs.

Other aspects of deterrence should also be considered in evaluating

the adequacy of penalty provisions. These aspects include the

likelihood that noncompliance will be detected and the credibility and

predictability of responses to noncompliance. These aspects should be

considered in light of administrative procedures and resources

established within the EIP, as well as other program design elements

related to emission quantification and monitoring, recordkeeping, and

reporting.

I. Interface With Existing Emission Trading Policies

The EIP rules and guidance, being broadly applicable to any kind of

EIP, generally cover the same type of emission trading programs that

have historically been addressed by the EPA's previously released

guidance on emission trading, primarily contained in the Emissions

Trading Policy Statement (ETPS) and its appendices (51 FR 43831, Dec.

4, 1986). Although based upon the same general principles, the EIP

rules and guidance provide both greater flexibility and more

comprehensive programmatic requirements for such programs. The proposal

defined the relationship between the EIP rules and the ETPS such that

the provisions of the ETPS which apply to trading between existing

sources (i.e., the bubble and generic bubble provisions) would

represent one particular model for how States could choose to design

such a program that would be approvable under the EIP rules. The

proposal, however, in no way constrained EIP's involving emission

trading to the specific provisions of the ETPS. The proposal solicited

comments on this proposed relationship.

Only a few commenters addressed this issue. Two commenters agreed

with the proposed approach. Another commenter disagreed with retaining

the elements of the ETPS that are now addressed by the EIP rules, on

the basis that such ETPS provisions are rendered obsolete by the new

rules, and the EPA should not encourage the use of less flexible

policies. Another commenter recommended that the ETPS should be updated

to include the flexibility contained in the EIP rules and that it

should then continue to be applied to trading done for the purpose of

meeting other statutory requirements (e.g., RACT/non-RACT trading).

The final rules retain the proposed relationship between the ETPS

and the EIP rules. The final rules do not encourage States to limit

their design of EIP's to meet the specific provisions in the ETPS.

However, the final rules recognize that States may want to implement

emission trading without embarking on the design of new approaches to

emission trading. Retaining the ETPS provides a known regulatory option

for those States that want to apply it.

J. General Issues

1. Detailed vs. General Guidance

Some commenters felt that the EIP proposal was overly specific and

limited flexibility. These commenters contended that it would be

difficult for EPA guidance to anticipate and identify all of the

specific elements of proposed programs that might be approvable until

actual programs are developed and adopted. They felt that the final EIP

rules should be limited to a detailed policy statement and discussion

of principles and criteria to which EIP's must adhere rather than

specific guidance on how EIP programs should be designed and

administered.

Other commenters, including a State and an environmental group,

felt that the final rules should include more detailed guidance. One

such commenter felt that without more detailed guidance, technical

questions such as how to calculate emissions reductions or to establish

baselines might be so daunting as to discourage attempts to develop

EIP's. This commenter felt that the need for such guidance is

particularly great for EIP's relying on area and mobile source

emissions reductions. Another such commenter felt that without more

detailed guidance spelling out appropriate design criteria and policy

and legal limitations, States will succumb to pressures to develop

EIP's that do not effectively implement the requirements of the Act.

Some commenters on both sides of this issue recommended that the

EPA provide examples of successful, appropriate EIP's. Such commenters

recommended that such information be provided through supplemental

documentation or through an EPA-established EIP information

clearinghouse.

Just as an individual State EIP rule should balance flexibility

with specificity, the EPA's final EIP rules should do the same. Thus,

the final rules retain the balance between general statements of

principles and criteria and specific detailed guidance on technical

requirements that was reflected in the proposal. The final rules

provide sufficient detail to allow States to design and implement EIP's

that will effectively implement the requirements of the Act without

defeating the purpose of capturing the benefits of market-based

regulatory approaches.

Although the final rules do not include specific examples of EIP's

that have been successfully implemented, the EPA agrees that such

information is a useful and important aspect of encouraging the

development of such programs. For the last 3 years, the EPA has funded

grants to support market-based initiatives by State, regional and local

agencies.16 All such initiatives have included strong involvement

from the State, affected local interests, and the relevant EPA Regional

Office(s). Final reports from these projects are available from the

States to further the EPA's goal of disseminating information about the

design and implementation of EIP's.

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\1\6The docket contains summaries of such programs and contacts

for information.

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Beyond this grant program, the EPA is committed to working with

individual States as they develop EIP's. In addition to the program

survey documents which have been placed in the docket, the EPA is

developing plans for future outreach activities to make information

about successful EIP initiatives as broadly available as possible.

2. Administrative Simplicity

Several commenters agreed that administrative complexity can be one

of the greatest impediments to a regulation and urged the EPA to

simplify the terms and processes of these rules. Such commenters felt

that undue administrative complexity would stifle the development of

EIP's and provide a significant disincentive for participation in

trading programs. These commenters generally felt that the EIP rules

should minimize regulatory barriers because they interfere with the

functioning of desirable market mechanisms which are necessary for the

success of the EIP.

One type of complexity cited by two State commenters related to

excessive government process, and the associated lack of timeliness, in

the review of individual emissions trades. These commenters recommended

that individual emissions trading transactions not be required to be

submitted to the EPA for review once a State's generic trading rule has

been approved by the EPA. Further, one such commenter recommended more

focus on the audit and evaluation of an EIP program, rather than on

administrative burdens upfront in implementing emissions trades. This

commenter felt that the EPA should have the authority to conduct

periodic audits of emissions trading transactions approved by the

States to assure the integrity of the program.

In seeking to provide States with the flexibility to implement

emissions trading programs effectively, the final EIP rules retain the

proposed requirement for the State to establish appropriate

administrative procedures for conducting, approving, verifying,

recording, and tracking trades. As part of an EIP program, these

procedures would then be reviewed by the EPA in the course of EPA

review of the SIP revision incorporating the EIP into the SIP. Thus,

the EIP does not necessarily envision single-source SIP revisions for

each trade conducted in the context of an EPA-approved generic

emissions trading program. Of course, EPA approval of such programs is

predicated on the program containing all the appropriate environmental

safeguards that are required by the EIP rules. One such safeguard is

the inclusion of program audits, to be conducted by the State, to

evaluate program implementation and track program results. The EIP

rules require that the State provide post-audit reports to the EPA, and

that the State commits to implement timely programmatic revisions or

other measures necessary for the successful operation of the program.

Additionally, the rules require that State and Federal enforceability

must be preserved, such that when ERC's generated within an emissions

trading program are used to offset increases in emissions from other

sources, the EIP must contain a mechanism for ensuring State and

Federal enforceability of the measures taken to generate the credits.

The EPA is currently developing additional guidance on such issues

associated with banking of ERC's. The EPA intends to complete this

additional guidance as quickly as possible, and, in the interim, to

work with States developing EIP's involving banking of ERC's.

3. Regional and Interstate Trading

Neither the proposal nor final rules specifically address the issue

of regional and interstate emissions trading. Several commenters raised

this issue, however, particularly in the context of trading of

emissions offsets. Most such commenters felt that the EPA should

encourage interstate trading by establishing consistent rules and

prohibiting States from creating interstate barriers. One State group

felt that the final rules should provide for the fullest possible

implementation of trading strategies on a regional basis within the

Northeast Ozone Transport Region. One environmental group urged that

the final rules remind States of the statutory geographical constraints

on trading.

The EPA has developed some preliminary guidance on this issue as it

relates to NOx offsets in the Northeast Ozone Transport

Region.17 Additional guidance on interstate or regional trading

will be developed in the context of the EPA's working with interested

States in program development activities.

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\1\7This guidance is contained in a March 31, 1993 letter from

Mr. John Seitz, Director of the EPA's Office of Air Quality Planning

and Standards, to Mr. Bruce Carhart, Executive Director of the Ozone

Transport Commission, which includes all or portions of the

northeastern States from Washington, DC, to the New England States.

This letter is available in the docket for this rule.

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V. Administrative Requirements

A. Executive Order 12866

Under Executive Order 12866, (58 FR 51735 (October 4, 1993)) the

Agency must determine whether the regulatory action is ``significant''

and therefore subject to OMB review and the requirements of the

Executive Order. The Order defines ``significant regulatory action'' as

one that is likely to result in a rule that may:

(1) Have an annual effect on the economy of $100 million or more or

adversely affect in a material way the economy, a sector of the

economy, productivity, competition, jobs, the environment, public

health or safety, or State, local, or tribal governments or

communities;

(2) Create a serious inconsistency or otherwise interfere with an

action taken or planned by another Agency;

(3) Materially alter the budgetary impact of entitlements, grants,

user fees, or loan programs or the rights and obligations of recipients

thereof; or

(4) Raise novel legal or policy issues arising out of legal

mandates, the President's priorities, or the principles set forth in

the Executive Order.''

It has been determined that these rules are not a ``significant

regulatory action'' under the terms of Executive Order 12866. This

action was submitted to OMB for review. Changes made in response to OMB

suggestions or recommendations will be documented in the public record.

B. Paperwork Reduction Act

These rules do not contain any information collection requirements

subject to review by the OMB under the Paperwork Reduction Act of 1980,

44 U.S.C. 3501, et seq.

C. Regulatory Flexibility Act

The Regulatory Flexibility Act of 1980 and applicable EPA

guidelines revised in 1992 require Federal agencies to identify

potentially adverse impacts of Federal rules upon small entities. Small

entities include small businesses, organizations, and governmental

jurisdictions. In instances where significant impacts are possible on a

substantial number of these entities, agencies are required to perform

a Regulatory Flexibility Analysis (RFA).

This rule does not of itself impose any requirements on small

entities, nor require or exclude small entities from any EIP's which

may be implemented in the future. As a result, the EPA has determined

that these rules will not have a significant impact on a substantial

number of small entities.

Therefore, as required under section 605 of the RFA, 5 U.S.C. 601

et seq., I certify that these rules do not have a significant impact on

a substantial number of small entities.

List of Subjects in 40 CFR Part 51

Administrative practice and procedure, Air pollution control,

Carbon monoxide, Intergovernmental relations, Lead, Nitrogen dioxide,

Ozone, Particulate matter, Reporting and recordkeeping requirements,

Sulfur oxides, Volatile organic compounds.

Dated: March 15, 1994.

Carol M. Browner,

Administrator.

For reasons set out in the preamble, 40 CFR part 51 is amended as

follows:

PART 51--REQUIREMENTS FOR PREPARATION, ADOPTION, AND SUBMITTAL OF

IMPLEMENTATION PLANS

1. The authority citation for part 51 continues to read as follows:

Authority: 42 U.S.C. 7401-7671q.

2. Part 51 is amended by adding a new subpart U, consisting of

Secs. 51.490 through 51.494, to read as follows:

Subpart U--Economic Incentive Programs

Sec.

51.490 Applicability.

51.491 Definitions.

51.492 State program election and submittal.

51.493 State program requirements.

51.494 Use of program revenues.

Subpart U--Economic Incentive Programs

Sec. 51.490 Applicability.

(a) The rules in this subpart apply to any statutory economic

incentive program (EIP) submitted to the EPA as an implementation plan

revision to comply with sections 182(g)(3), 182(g)(5), 187(d)(3), or

187(g) of the Act. Such programs may be submitted by any authorized

governmental organization, including States, local governments, and

Indian governing bodies.

(b) The provisions contained in these rules, except as explicitly

exempted, shall also serve as the EPA's policy guidance on

discretionary EIP's submitted as implementation plan revisions for any

purpose other than to comply with the statutory requirements specified

in paragraph (a) of this section.

Sec. 51.491 Definitions.

Act means the Clean Air Act as amended November 15, 1990.

Actual emissions means the emissions of a pollutant from an

affected source determined by taking into account actual emission rates

associated with normal source operation and actual or representative

production rates (i.e., capacity utilization and hours of operation).

Affected source means any stationary, area, or mobile source of a

criteria pollutant(s) to which an EIP applies. This term applies to

sources explicitly included at the start of a program, as well as

sources that voluntarily enter (i.e., opt into) the program.

Allowable emissions means the emissions of a pollutant from an

affected source determined by taking into account the most stringent of

all applicable SIP emissions limits and the level of emissions

consistent with source compliance with all Federal requirements related

to attainment and maintenance of the NAAQS and the production rate

associated with the maximum rated capacity and hours of operation

(unless the source is subject to federally enforceable limits which

restrict the operating rate, or hours of operation, or both).

Area sources means stationary and nonroad sources that are too

small and/or too numerous to be individually included in a stationary

source emissions inventory.

Attainment area means any area of the country designated or

redesignated by the EPA at 40 CFR part 81 in accordance with section

107(d) as having attained the relevant NAAQS for a given criteria

pollutant. An area can be an attainment area for some pollutants and a

nonattainment area for other pollutants.

Attainment demonstration means the requirement in section

182(b)(1)(A) of the Act to demonstrate that the specific annual

emissions reductions included in a SIP are sufficient to attain the

primary NAAQS by the date applicable to the area.

Directionally-sound strategies are strategies for which adequate

procedures to quantify emissions reductions or specify a program

baseline are not defined as part of the EIP.

Discretionary economic incentive program means any EIP submitted to

the EPA as an implementation plan revision for purposes other than to

comply with the statutory requirements of sections 182(g)(3),

182(g)(5), 187(d)(3), or 187(g) of the Act.

Economic incentive program (EIP) means a program which may include

State established emission fees or a s

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